Trimming back on a winner locks in your gains and positions you better. Photo / Supplied
Trimming back on a winner locks in your gains and positions you better. Photo / Supplied
I hear it repeatedly from investors: "I want to get more hands-on about my investments, but everything I read about investing sounds like a foreign language!"
One of those terms that financial advisers like me use often is "rebalancing your portfolio". The concept of re-balancing is quite simple – butat its core, it is a powerful risk-minimising strategy by ensuring that your portfolio is not overly dependent on the success or failure of one asset class or investment style.
As some investments perform better over time than others, the balance of your investments shifts as time goes by. Rebalancing is the act of bringing your portfolio back to its desired asset mix by taking profits out of certain outperforming investments and re-investing those returns in underperforming assets.
Periodic rebalancing is generally a good way to keep your investments on track and to prevent your portfolio from changing too drastically during volatile markets – like the one we are experiencing now with the Covid-19 outbreak.
Let's say that after assessing how much investment risk you can handle – which your adviser will determine based on your risk tolerance – you've decided the right balance of risk vs return is 70 per cent of your savings in stocks and 30 per cent in bonds.
After a good year in the stock market, your stocks have skyrocketed, but your bonds have plodded only slightly higher. What started as a portfolio with 70 per cent stocks, 30 per cent bonds shifted to 80 per cent stocks, 20 per cent bonds.
By rebalancing your portfolio, your financial adviser will restore the original target allocations by selling assets that have appreciated and adding to those that have declined.
You might think: Why not let the winners keep on rolling indefinitely? It's natural to want to hold on to the winners in your investment portfolio. The reality is, nothing keeps winning forever.
Colleen Jaconetti, a senior analyst with Vanguard, said: "People don't want to re-balance when the stock market is doing well, but what if the stock market did drop 20 per cent and they had not re-balanced?"
The risk, then, noted Colleen, is that by letting the equity portion ride, investors may end up with a much higher allocation to equities than they are comfortable with.
Trimming back on a winner locks in your gains and positions you to benefit from the changes in market cycles. And, you want to make sure that it's you who's controlling the amount of risk you take in your investment portfolio, not the ups and downs of the market.
Nick Stewart
As Vanguard notes about re-balancing: It is important to keep in mind that the primary benefit of portfolio rebalancing is to maintain the risk profile of an investment portfolio over time, rather than maximise returns.
Covid-19: Rethinking investments
The outbreak of Covid-19 has ushered in a new situation. We have oscillated to a bear market from a firm bull market within 30 days. Risk sits at the forefront of every investor's thinking right now. For retirement savers, it is uncomforting to see the value of their portfolios shrink substantially within such a short period.
A good adviser will use an investment strategy as the rulebook; some key principles would be: • A belief in markets • Understanding the risk/return characteristics of assets • Diversification • How portfolio construction determines returns • Maintaining discipline • Smart portfolio rebalancing • Cashflow management tuned to the investor • Selection of quality assets • Choice of a reliable custodian • Low asset and custodian fees • No commission from asset managers
None of the principles eliminates the investment risk, but the data behind each forms an evidence-based process where risk is understood, and rude surprises are minimised. They help control the process to the highest possible extent. The one uncontrollable is the market.
Current market movements aren't welcome, but there is an expectation they occur. Planning occurs around worst-case scenarios. Investors experiencing an asset price decline have cash and fixed interest to draw upon through times of trouble.
Investors and financial advice providers operating without evidence and with no investment philosophy are now receiving a lesson in the risk they didn't price. Unfortunately, the unpriced risk is sharp, and it is ruthless.
• Nick Stewart is an Authorised Financial Adviser and CEO at Stewart Group, a Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, wealth management, risk insurance and KiwiSaver solutions.
• This article is prepared in association with Mancell Financial Group, Australia. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
