Rebalancing portflolio helps weather the storms

The investing landscape is going to be harder to navigate from here, and strong returns will be more difficult to come by. Photo / NZME.

Investment portfolios sometimes need a health check to make sure they can withstand any troubles ahead.

We've been talking a lot lately with our clients about "rebalancing". Some will say this sounds like finance industry jargon, and it is. What we really mean to say is that it might be time to sell some of your shares and put the money into lower-risk assets, in case something goes wrong. It sounds so much harsher to spell it out like that, so we opt for recommending that you "rebalance".

Whatever you want to call it, the concept is fairly straightforward, and very sensible. Consider an investor who started with a portfolio that was split 60/40 between growth assets (shares and listed property) and income assets (fixed interest and bank deposits) three years ago.

If no adjustments have been made over this period, the growth assets will have performed so strongly that they will now represent a much greater part of the pie than before. The growth/income split will have moved closer to 70/30, which means the risk profile and potential volatility of the portfolio has increased.

If markets hit another rough patch, the portfolio won't weather the storm as much as it would have before, because it is much more skewed to growth assets that are more sensitive to changes in the economy or market sentiment in general.

This investor should consider taking profits in some of the growth assets that have performed so well and adding to the income assets, to bring the overall portfolio closer to its original 60/40 split.

Markets have had a massive run over the past several years. US shares have increased three-fold compared to where they bottomed in March 2009, while the NZX50 is 67.5 per cent above its low point. The US market is now more than 35 per cent higher than its 2007 peak.

The investing landscape is going to be harder to navigate from here, and strong returns will be more difficult to come by. While some progress has been made over the past few years, the global recovery is fragile and there are risks aplenty. Higher valuations mean these risks will hit harder if they eventuate.

Low interest rates have been the single biggest driver of the strong returns we have seen in recent years, and many people have underestimated just how much this would impact investor behaviour. Many would argue this dynamic isn't going to change anytime soon and that markets could remain well-supported for a few more years yet.

This may well be right, but one could also argue that these low interest rates simply reflect lower economic growth, lower inflation and lower potential for growing profits. All those things should cause share prices to go down, not up.

It's always difficult to predict when to take some money off the table and move to the sidelines. However, rebalancing is about managing risk, not necessarily chasing better returns or trying to time the market.

Taking profits or de-risking your portfolio doesn't mean selling everything. There are plenty of reasons to keep a healthy allocation to shares and there are many great companies that will prosper, even in the face of negative sentiment and weaker economic conditions.

Rebalancing is about giving your portfolio a health check and making sure it's positioned to weather some potentially stormy market conditions. Most importantly, it's about making sure your portfolio matches your risk profile.