Rebalance your investment portfolio: What it means and how to do it

After a solid year for stock and property investments last year, investors may have more of their investments in those two categories than they planned.

The beginning of the new year is a good time to rebalance and bring your mix of investments back to the right level.

HOW TO ALLOCATE ASSETS

Before looking at rebalancing, it is important to start by reviewing your goals and how you allocate your assets.

Your goals include both what you want to do and how far away those objectives are.

Your child’s education may be close at hand, for example, while retirement may be far in the future. 

Along with reviewing your objectives, consider how much risk you are willing to take.

Your strategy for allocating your assets will be different depending on whether you are risk-averse and cannot stand losing money, or you are willing to tolerate losses to get a higher return, or you are somewhere in between.

Once you know your goals, timeframes and risk tolerance, you can decide whether to keep or change your allocation of investments between stocks, bonds, property or other assets — that is, what percentage of your money to put into each category.

Someone in their 20s or 30s who is willing to take some risk, for example, may allocate a relatively high 70 or 80 per cent of their funds to more volatile stocks and the rest to real estate investment trusts (Reits) or bonds.

A person in their 50s who is nearing retirement or a risk-averse person of any age may decide to put more than half of their money into relatively safe bonds, a little into stocks, and the remainder into safe fixed deposits despite their yielding a low return.

Others take a balanced approach of about a third each in stocks, bonds and Reits.

Investment advisory firm Merrill says: “Research suggests that this (allocation) decision may be the most fateful choice you can make for building a portfolio to meet your needs.”

It could help you ride out market highs and lows by helping to minimise the potential impact of market fluctuations.

HOW INVESTMENTS GET ‘OUT OF BALANCE’

Regardless of what asset allocation you choose, your investments are likely to get out of balance over time.

Last year, for example, the Straits Times Index of stocks gained about 5 per cent and the S&P Singapore Bond index rose about 4.7 per cent.

If you invested only in stocks and bonds, your portfolio might still be about balanced.

On the other hand, the iEdge S-Reit Index that tracks Reits listed on the Singapore Exchange returned about 24.9 per cent last year and the S&P 500 Index of stocks in the US rose by more than 28 per cent.

If you had Reits or US stocks in your portfolio, your investments may have shifted heavily towards property and stocks.  

HOW TO REBALANCE YOUR PORTFOLIO

Rebalancing your portfolio means, very simply, strategically selling one type of investment and buying another in order to maintain your target asset allocation.

Ms Christine Benz, director of personal finance with financial services firm Morningstar, says that rebalancing is one of the best ways to improve your portfolio's return and improve its risk level.

You should evaluate your portfolio at least once a year to see whether your allocations still match your targets. The start of a new year is a good time for a review.

If the percentage in each category is more than about 5 per cent away from your target allocation, it is time to rebalance.  You can also look at whether there were significant shifts within categories, such as growth stocks crowding out value stocks in your portfolio.

If you need to rebalance, three steps can get you back on track.

1. First, calculate the total value of each category of asset in your portfolio and determine the percentage of your assets in each category — of stocks, bonds, Reits or other assets.

2. Next, compare those percentages with your target asset allocation and, if the percentages don’t match your targets, calculate the amount of each type of asset you will need to buy or sell to get your portfolio back in balance.

3. Finally, determine which assets to sell and what to buy in each asset class, and make the changes for rebalancing.

If your target allocation is fairly typical, with 60 per cent in stocks and 40 per cent in bonds, you may find that strong US stock market performance resulted in 75 per cent being in stocks and 25 per cent in bonds. Rebalancing will return you to your target allocation.

If you invest in stocks and bonds using exchange-traded funds (ETFs) or index funds, the process can be quite simple.

You can sell ETFs in the category where your assets are too high and buy ETFs in the category where your assets are too low. You can also buy or sell Reits or a Reit ETF if you invest in property.

If you invest directly in stocks and bonds, you will need to do more research, then sell ones with less potential and buy ones with higher likely long-term returns.

The straightforward process of rebalancing, which can take less than an hour or two a year, can keep you on track towards reaching your financial goals and give you peace of mind as well as better returns.