Financial advisors like to meet you all the time about it, finance apps brag about “auto-rebalancing,” and finance students procrastinate when doing it as homework. I think we can conclude at this point that it’s (1) inconvenient and annoying for everyone, and (2) time-consuming. Like most things we hate having to do however, it’s absolutely necessary:
A rundown on portfolio rebalancing
When you’re in single-digit millionaire territory, your portfolio gets a bit more complex. For starters, the retirement assets are no longer 70 per cent your HDB flat (don’t even try to tell me that isn’t the case for most average Singaporeans these days).
You need a wider range of assets, such as stocks, bonds, alternatives, etc. The exact constituents of your portfolio may vary, and it’s what you overpay at finance seminars to learn (or just, you know, get a wealth manager).
But assuming it’s a balanced, well-diversified portfolio, it may have a general asset allocation that looks like this:
- 70 per cent equities
- 20 per cent fixed income
- 10 per cent cash
(Again, not everyone’s portfolio looks like that, and those assets will break down further into varied categories – this is just a general example).
Here’s the problem: investment portfolios are like weeds or toenails. If you don’t keep cutting and trimming, they overgrow those given boundaries. For example:
Say I have $500,000 in an investment portfolio. Based on the allocation above, it should look like this:
- $350,000 in equities (70 per cent)
- $100,000 in various fixed income securities (20 per cent)
- $50,000 in cash, probably as my emergency fund (10 per cent)
That’s fine and good. But a few years down the road, the value of my portfolio rockets up to $600,000. However, the equities have outperformed the others, while the fixed income portion underperforms – and I’ve used some of the cash. So now, my $600,000 portfolio looks like this:
- $480,000 in equities (it’s now 80 per cent of the portfolio)
- $100,000 in fixed income securities, that haven’t grown (it’s now around 16.6 per cent)
- $20,000 in cash, after I used some for emergencies (it’s now around 3.3 per cent)
The portfolio is growing in value, but you can see the asset allocation is now completely distorted from the original plan.
This is where the portfolio rebalancing comes in
This is when your wealth manager, financial representative, etc. gets to burn their weekend buying and selling off assets, till your portfolio fits the original allocation again.
In the above example, it would start with selling off equities till it shrinks back to 70 per cent again, and then allocating more to fixed income and cash (to get them back to 20 per cent and 10 per cent respectively).
Some of you will be asking what the hell, why would we sell the top performers?
But that way lies the danger of doubling down, or over-investing. You don’t want to behave like a gambler who, because you had a good run, are now throwing all your capital into that particular asset.
It’s an easy mistake to make, and this is one example of how rebalancing and asset allocation keeps your disciplined.
How often does portfolio rebalancing need to be done?
This depends on the type of rebalancing your financial manager chooses to do. In Singapore, the two most common approaches are calendar-based, constant-mix rebalancing, and algorithmic rebalancing.
Calendar-based rebalancing is used by financial advisors, wealth managers, etc. who don’t want to end up on Xanax prescriptions. It’s simply practical and effective: you set a date, such as every six months, to review the portfolio and rebalance it.
This is also conducive to your sanity, unless you actually enjoy repeated and very frequent meetings with your financial advisor (in which case, request a more constant form of rebalancing, so they can call you all the time to get your approval for things).
Constant-mix rebalancing is when a certain tolerance is given for each asset class; for example, we may say we allow the equities portion of your portfolio to grow or shrink by five per cent. Any more than that, and we’ll need to step in and start rebalancing.
This is a bit more “on the ball.” If there’s a big market movement for example, your wealth manager would be on it right away, as opposed to waiting for your semi-annual meeting at Ya Kun before rebalancing.
Algorithmic rebalancing isn’t a specific method per se, it just means you have a computer programme doing the rebalancing for you. The actual execution and strategy will differ based on the programme (it may even just be similar to constant-mix rebalancing).
Many finance apps like to boast that their system automatically handles the rebalancing for you; but you really need to probe a bit and question the transparency (or lack thereof). Quite often, the algorithm is proprietary, and you can’t get full details on how it works.
Besides these, there are other methods involved, such as smart-beta rebalancing, where the portfolio is tailored to a specific market index. These are outside our basic scope for now though, and the main thing most people need to grasp is why rebalancing matters.
Finally, there is such a thing as too much constant rebalancing
Rebalancing isn’t free. The costs may sometimes be small, but they do exist: every time you buy and sell an asset, there are typically small fees. If you keep shuffling your assets around, you’re likely to find the performance is affected in the long run.
So it’s important to have a clear-headed and well-defined approach here: the entire point of portfolio management is to be an objective, unemotional, ice queen / king when it comes to investing.
Stick to your rebalancing plans, and don’t’ slack off when you need to do it. I get that your eyes glaze over when your financial advisor opens the 200th Power Point graph, but financial planning is an ongoing process. It’s not a one-time thing, and you really need to do this.
For more help on this, reach out to us at Single Digit Millionaire. We help Singaporeans who are increasingly sandwiched, and see their wealth eroding to the rising cost of living.
