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Investor conundrum: Should you rebalance your portfolio?

by , 28 January 2014

One of the biggest challenges for any investor is to control your emotions. Human beings have a tendency to act in herds. They chase the latest hot investment and sell out of the least popular stuff. In other words, we instinctively buy high and sell low. But this is the exact opposite of what we should be doing. And that's what makes rebalancing a good idea. Let's take a closer look at whether you should rebalance your portfolio?

Rebalancing is all about getting the assets you own back to their initial target allocations, Phil Oakley in Money Week explains…

Think about this in terms of an overall portfolio. What happens is that the assets that do well (the ones that are getting more expensive) become an ever bigger part of your portfolio. But those that do badly (the ones that are getting cheaper) become a smaller part.

Say you don’t rebalance and shares enjoy a bull market. At the time, you’ll probably think it’s great – your portfolio will probably rise in value too.

By not rebalancing, your portfolio could become more risky

But it may also become a lot riskier than you would like it to be. If shares comprise 50% of your portfolio at the top of a bull market, then crash by 50% (as has been known to happen), your fund would lose a quarter of its value (50% of 50%).

With regular rebalancing you would at least limit the damage. You’d have been continually taking profits as shares went up in price, and reinvesting in assets that had performed poorly.

In the late 1990s equity bull market, for example, taking profits on shares and reinvesting in gold would have worked out well. Buying cheap shares after big sell-offs in 2003 and 2008/2009 also proved profitable, at a time when most investors were scurrying for the perceived safety of cash and bonds.

So rebalancing allows you to buy low and sell high. That’s a practice that tends to make you money in the long run – it’s almost like putting your portfolio on contrarian auto-pilot.

So there you have it, why you should rebalance your portfolio.



Investor conundrum: Should you rebalance your portfolio?
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