Rebalancing your investment plan is an important task we do at Wealthify. It’s part of the manage work we do when we say we ‘build and manage your plan’. Before we explain why we rebalance and how it works, let’s explain what it is.
What is a rebalance?
A rebalance of your investment plan happens when we reset your investments (sell some, buy others) to make sure the risk balance of your plan stays in line with the investment style you’ve selected.
Why do we rebalance your investment Plan?
Financial markets move up and down, and after some time, if your investment plan is left unchecked your plan may look very different to the one you selected.
How so? To make our point clearly, let’s use an extreme example. Let’s say your plan has a 50/50 split of shares and bonds, but shares perform very well whilst bonds decline in value, this split could potentially move to 80/20 in favour of shares. The difference in weights occurs due to market movements and not any investment decisions you’ve made.
Why does this matter? Because the split of investments moving from 50/50 to 80/20 means investment style and your portfolio’s risk level has changed – whether you wanted it to or not. – In this example, your risk level has increased and your medium risk investment plan, or Confident as we like to call it, now looks (and importantly behaves) more like a high-risk or Adventurous investment style. This means you now have a more volatile or higher risk plan than you signed up for, so to put you back as a medium risk investor your plan must be rebalanced.
Rebalancing also matters at the individual fund level not just investment types
The examples so far have been focused on the split of investment types, and how a significant change due to market movements can change the type of investor you are if you leave your plan unchecked for too long. But it also matters at the individual investment level.
We invest in a number of funds, which are essentially hampers full of investments, to help spread your money across investment types and regions. This means that you get an investment Plan with a good variety of investments – also known as a diversified plan – which could help to mitigate risk. Now, when we buy a certain amount of US shares, for example, through a fund it’s because we deem that it’s the appropriate amount, but if performance means that proportion doubles or triples in your investment Plan then it reduces your overall diversification and increases concentration risk. Having too much exposure to one fund even if it has performed well, can be a bad thing. It also works in the opposite direction when an investment is having a period of underperformance. If over the long-term, it remains an attractive investment, you may look to buy more at a cheaper price to push it back up in your Plan, then if it performs well, it should contribute reasonably towards your potential investment returns.
How does a rebalance work?
From the date of the last rebalance, the investments held in your Plan, unless they have all risen or fallen by exactly the same percentage, will have drifted away from the desired weights of each holding in the investment style you’ve selected. Some investments may be larger and some smaller in weight due to market performance. So, in this situation, we would trim back the investments that are bigger holdings and use the sale proceeds to top up your plan with the investments that are smaller. This buying and selling process to level the investments in your Plan is how a rebalance works, trimming the winners and topping up the losers.
How often should I rebalance my investment plan?
If you’re reading this as an investor who manages your own investments, that decision is completely up to you. There are two forces which may drive your decision to rebalance, time period and drift.
Time period rebalancing
It may be that you religiously rebalance your investment plan every 3 months, 6 months, or 12 months – they’re the most commonly used frequencies. Time period rebalancing strategies take the emotion out of the decision, and if you can automate it – even better. Unfortunately, this approach alone can see plan risk levels get significantly away from their desired level in sharp market moves.
When we have been talking about rebalancing due to market movements, this is also known as drifts. This type of rebalancing may be a preferred option for investors who don’t wish to mechanically rebalance periodically, or are happy to take on added risk when their portfolio changes. Typically, investors will have a pre-set level of tolerance for plan fluctuations although some investors may alter this due to market conditions.
How do we rebalance your investment Plan at Wealthify?
We adopt a hybrid approach of time-period and drift rebalance strategy. Our investment team include a time-period rebalance of around three months to pull your Plan back in line with the investment style you’ve selected, then we overlay that with a drift rebalancing process for times when markets are experiencing higher levels of volatility (ups and downs).
To wrap up
If you’re a Wealthify investor then, lucky for you, rebalancing is part of our service, so you don’t have to worry about it. But, anytime you hear or read the word “rebalance” in the context of investing, just think of a reset and that is pretty much exactly what it is – just a bit more jargon that we like to use in the investment world!
Please remember the value of your investments can go down as well as up, and you could get back less than invested.