The Rebalancing Decision

Investment portfolios should be constructed with a particular objective in mind, while attempting to take on the least amount of risk to achieve the objective. This is often done by finding a mix of asset classes of varying risk levels and funds of different investment styles or fund managers.

An example of a portfolio of moderate risk could consist of an asset mix of 20% in cash, 40% in bonds and 40% in equities, this is commonly referred to as a target allocation. The target allocation is therefore the allocation that aims to achieve the objective of the portfolio through time.

If left unchanged over time, these allocations will change as the asset classes perform differently relative to each other. Over the longer term, the equity component could grow far larger than 40% of the portfolio, while the allocations to bonds and cash could shrink in relative size. The portfolio then would be on a different risk level and as an investor your investment might not match your risk profile. Therefore, once the portfolio is established it is important to review investment allocations against the target allocation and make a decision to rebalance the portfolio back to the target allocation, if necessary.

Rebalancing a portfolio back to the target allocation means effectively selling the higher performing asset classes or funds and buying more of the lower performing ones. This may seem counter-intuitive but the decision to rebalance does have its merits. As markets tend to moves in cycles, so do the performance of asset classes and fund managers. A particular fund manager’s strategy might not pay off while another’s performs well, but as the investment cycle changes, the underperforming fund manager’s strategy could turn out on top.

Another aspect to bear in mind when rebalancing an investment portfolio is that it may be subject to Capital Gains Tax (CGT). Although the CGT implication should not prevent the rebalancing of a portfolio that has drifted significantly from its target allocation and objective, it is a factor that could have a material impact on net investment returns and the investors’ tax bill in the given year.

There are various factors to consider in making a decision to rebalance These include how far the portfolio has drifted from its target allocation and whether the current allocation is within an acceptable range of risky assets. We believe it is important to have a disciplined approach to rebalancing, with certain set criteria to be followed.

Article contributed by Independent Wealth Managers (Pty) Ltd.

Independent Wealth Managers is a FPI Approved Professional PracticeTM and authorised financial service provider; FSP No. 3145.

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The information in this communication is based on current legislation (2017) and is not to be construed as advice in terms of the Financial Advisory and Intermediary Services Act of 2002 (‘FAIS’).