When A Portfolio Loses Its Balance
Just think of what your portfolio might look like if you never followed one of the principles of sound investment practice – that is to regularly rebalance your portfolio back to its strategic or target asset allocation.
Recent Vanguard analysis illustrates how a portfolio can get seriously out of kilter without rebalancing. Their findings may surprise you.
To make their point, analysts took a hypothetical portfolio that was established in January 1926 and not rebalanced even once over the next 90 years.
For the sake of the exercise, the portfolio began life with an equal exposure to global shares and global bonds. (Assumptions include no new contributions or withdrawals. Dividends were reinvested in shares, and taxes were not taken into account.)
This once 50/50 hypothetical portfolio would have begun January 2016 with 97 per cent of its portfolio in shares. Its average exposure to shares over the 90 years was 81 per cent. Nothing like what the now-ageing investor would presumably have had in mind all those years ago.
Without the originally-desired exposure to bonds, the portfolio had become progressively more volatile and risky – placing an investor in a weaker position to meet long-term financial goals. (As reflected in the standard deviation* for the portfolios, as shown the table below, the annual returns of the never-rebalanced portfolio were much more volatile.)
And significantly, the average annual return of the never-rebalanced portfolio was only slightly higher – 8.8 per cent against 8 per cent – than for the regularly-rebalanced portfolio.
|1926-2015||Annually rebalanced||Never rebalanced|
|Maximum share weighting||60%||97%|
|Minimum stock weighting||35%||27%|
|Average stock weighting||51%||81%|
|Final stock weighting||49%||97%|
|Average annualised return||8%||8.8%|
|Annualised standard deviation*||9.8%||13.2%|
Source: Vanguard calculations based on data from FactSet.
Disciplined rebalancing can present some emotional challenges for investors such as at times when one asset class has been performing much more strongly than other parts of their portfolios, which may have been struggling. Another practical issue is to decide when to rebalance.
Over the next week, Smart Investing will look at developing a practical rebalancing strategy for your portfolio.
*Standard deviation is a widely-used tool to measure the degree of fluctuation of a portfolio's return. The higher the standard deviation, the higher the volatility in returns.
Robin Bowerman is Head of Market Strategy and Communication, Vanguard Australia. As a renowned market commentator and editor Robin has spent more than two decades writing about all things investment.