Why now’s the time to rebalance your investment portfolio
It’s said that every cloud has a silver lining. In the case of weakened share markets we believe it’s a better long-term outlook.
I don’t mean economic prospects are looking up. They’re not. The economic wounds caused by the Covid-19 crisis will take time to heal and leave scars even after output recovers.
I also don’t mean that the worst is necessarily over for stock markets or that share prices won’t sink further if we get secondary waves of infection.
But I do mean share valuations have come down far enough for us to significantly revise our expectations up for long-term stock market returns.
As such, it makes little sense for investors to halt their regular share investing, let alone sell their existing share holdings, at these levels.
If anything, now is an ideal time for UK investors to review their portfolios and consider whether they need rebalancing. And that, in turn, could well mean them buying more shares.
For UK-based investors, Vanguard is forecasting annualised average returns over the next 10 years of between 6% and 8% for UK shares and between 6.6% and 8.6% for international shares on an unhedged basis.
That’s around two percentage points higher than at the end of 2019 – three in the case of international shares.
The changed outlook is a reflection of just how much share valuations were stretched at the end of last year and how far they’ve fallen since.
But it’s also an opportunity for investors to consider whether their portfolios are still fit for their purposes.
In particular, what if your desired split of shares and bonds – the so-called asset allocation that should underpin your investment strategy – moves out of line with your investment goals?
Different markets move in different directions all the time and these differences are accentuated when you have the kind of big price moves we’ve had of late.
So with shares becoming cheaper in recent months and bonds more expensive, you may have started the year with an 80:20 split between the two asset classes but got to May with a 70:30 or even 60:40 split.
Why should this matter?
Because this ratio is meant to reflect the desired trade off in your portfolio between investment risk and reward – as shaped by your goals.
In broad terms, the longer your timeframe, the more you can afford to take on risk by having more shares in your portfolio relative to bonds. Time is on your side, so you can ride out any market setbacks more easily.
The less time you have, the more the opposite is true.
Shares tend to be more volatile than bonds but historically they have been more rewarding over the long-term. It’s why we recommend periodic rebalancing, in order to maximise your chances of benefiting from the market’s full potential.
Getting your portfolio back up to weight in equities means that when the markets do recover and start reaching new highs again, your portfolio will reap the rewards.
Using the example above, if your asset allocation has fallen from an 80:20 equity bond split to a 60:40 split, unless you rebalance, that lower equity weighting will not give your portfolio the growth it was designed to do.
Of course, some multi-asset funds do this automatically. Some even alter the mix as you get closer to retirement and your need to begin accessing your investments increases.
Most funds don’t though, which puts the onus on the individual investor to periodically rebalance their portfolio – especially after major market moves.
Rebalancing your investments can be tough. Selling bonds and buying relatively riskier shares could feel counterintuitive when the economic backdrop is as uncertain as it is now.
But it’s worth remembering that not all businesses suffer equally under extreme economic conditions. Take online services and food retailers, some of which are flourishing even now. So as long as you maintain a sufficiently diversified portfolio, you can always continue to harness the long-term growth potential of the stock market. There’s safety in numbers.
The advantage of periodic rebalancing also is that it helps to remove some of the emotions that can lead to common investor mistakes such as buying high and selling low. So rather than being driven by the twin imposters of greed and fear, be guided instead by reason and sensible financial planning.
It’s a great way to break the cycle of bad investor behaviour.
So don’t worry if you don’t catch the very bottom of the market. Look to rebalance your portfolio in line with your investment goals. It’ll put you in a better position in the long-run.
James Norton is senior investment planner for Vanguard UK