Bring your investments back in line with our free portfolio rebalancing calculator.
Portfolio rebalancing is simply the process of adjusting your portfolio back to its original ratios by buying and selling ETFs or other investments. It’s a way of controlling your portfolio’s risk level and ensuring that your investments align with your long-term objectives.
Picture this: you’ve carefully chosen your ETFs or shares and decided on the perfect ratio to match your risk tolerance and investment goals. You sit back, relax, and let your investments grow. However, over time, the value of your investments will fluctuate due to market movements, causing your portfolio to drift away from your original allocation. This is where portfolio rebalancing comes in.
Our portfolio rebalancing calculator is fairly self explanatory. Enter the names of your ETFs or other investments and their current value, and what percentage of your portfolio you’d like each to occupy. Click the calculate button and below you will find out exactly how much you need to buy and sell of each investment to bring your portfolio back into balance.
Portfolio Rebalancing Calculator
Your Portfolio Details
| Investment Name | Investment Value (£) | Target Allocation (%) |
|---|---|---|
Rebalancing Result
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Below we’ll dive deep into the world of portfolio rebalancing. We’ll explore the reasons behind rebalancing, various rebalancing strategies, and how to implement them effectively. Whether you’re a seasoned investor or just starting, understanding the art of rebalancing is essential for navigating the ever-changing landscape of the financial markets.
Understanding Portfolio Rebalancing
Portfolio rebalancing is the process of adjusting the weightings of assets in your investment portfolio to maintain your desired asset allocation. In simpler terms, it’s the act of periodically buying and selling ETFs or other investments to ensure that your portfolio’s risk level and asset composition remain where you want them.
Why rebalancing is necessary
- Maintaining desired asset allocation: Over time, the value of your investments will fluctuate due to market movements. For example, if equity markets perform well, your stock ETFs may grow faster than your bond ETFs, causing your portfolio to become more heavily weighted towards stocks. Rebalancing helps you maintain your desired asset allocation, ensuring that your portfolio’s risk level remains in line with your tolerance and goals.
- Managing risk: By regularly rebalancing, you effectively manage the risk in your portfolio. When left unchecked, a portfolio can become overexposed to certain asset classes, potentially increasing your risk beyond your comfort level. Rebalancing allows you to trim positions that have become overweight and reinvest in underweight assets, thus keeping your portfolio’s risk in check.
- Taking advantage of market fluctuations: Rebalancing can also help you take advantage of market fluctuations. By selling ETFs that have become overvalued and buying those that are undervalued, you are essentially following the age-old investment adage of “buying low and selling high.” This disciplined approach can help you capitalise on market inefficiencies and potentially enhance your portfolio’s returns over the long term. And because it happens on a regular schedule, it’s also systematic, which means you don’t fall into the trap of trying to time the market.
Understanding the concept and importance of portfolio rebalancing is the first step towards effectively managing your portfolio. In the next section, we’ll explore how your risk tolerance and investment timeline influence your asset allocation strategy.
Asset Allocation and Risk Tolerance
Importance of determining your risk tolerance
Before diving into portfolio rebalancing, it’s crucial to understand your risk tolerance. Risk tolerance is the degree of ups and downs that you are willing to withstand (and let’s be honest, we are mostly talking about downs here.) It’s a personal measure that depends on various factors, such as your age, income, investment goals, and emotional response to market fluctuations. Assessing your risk tolerance helps you determine the appropriate asset allocation for your portfolio, which in turn influences your rebalancing strategy.
Different asset allocation strategies
Asset allocation refers to the proportion of your portfolio invested in various asset classes, such as stocks, bonds, and cash. The three main asset allocation strategies are:
- Conservative: A conservative asset allocation focuses on preserving capital and minimising risk. It typically involves a higher allocation to bonds and cash, with a smaller proportion invested in stocks. This strategy is suitable for investors with a low risk tolerance or those nearing retirement.
- Moderate: A moderate asset allocation strikes a balance between growth and stability. It usually consists of a relatively equal mix of stocks and bonds, with a small allocation to cash. This strategy is appropriate for investors with a medium risk tolerance and a longer investment timeline.
- Aggressive: An aggressive asset allocation prioritises growth and potential returns over stability. It typically involves a high allocation to stocks, with a smaller proportion invested in bonds and cash. This strategy is suitable for investors with a high risk tolerance and a long investment timeline.
Role of age and investment timeline in asset allocation
Your age and investment timeline play a big role in determining your asset allocation. Generally, younger investors with a longer investment horizon can afford to take on more risk, as they have more time to recover from market downturns. As you approach retirement, however, it’s arguably prudent to shift towards a more conservative asset allocation to preserve your wealth and generate income.
Understanding your risk tolerance and choosing an appropriate asset allocation are essential steps in creating a successful rebalancing strategy. In the next section, we’ll look at how often you should rebalance your portfolio.
Portfolio Rebalancing Frequency
Factors influencing rebalancing frequency
Deciding how often to rebalance your portfolio is a much talked about topic in investing. Several factors can influence your rebalancing frequency:
- Market volatility: During periods of high market volatility, your portfolio may deviate from its target asset allocation more quickly. In such cases, you might consider rebalancing more frequently to maintain your desired risk level.
- Investment goals and timeline: Your investment goals and timeline can also impact your rebalancing frequency. If you have a shorter investment horizon, you may need to rebalance more often to ensure that your portfolio remains aligned with your goals.
- Transaction costs: Rebalancing involves buying and selling investments, which incurs transaction costs such as brokerage fees and bid-ask spreads. Frequent rebalancing can eat into your returns, so it’s essential to strike a balance between maintaining your asset allocation and minimising costs.
Common rebalancing frequencies
- Annual rebalancing: Many investors choose to rebalance their portfolios once a year. This frequency is often sufficient for long-term investors with a well-diversified portfolio. Annual rebalancing allows for a systematic approach to portfolio maintenance while keeping transaction costs in check.
- Quarterly rebalancing: Some investors prefer to rebalance their portfolios every quarter (i.e., every three months). This frequency can be suitable for investors with a more hands-on approach or those with a shorter investment timeline. However, quarterly rebalancing may incur higher transaction costs compared to annual rebalancing.
- Threshold-based rebalancing: Threshold-based rebalancing involves setting a predetermined deviation from your target asset allocation that triggers a rebalancing event. For example, you might decide to rebalance your portfolio whenever an asset class deviates by more than 5% from its target allocation. This approach allows for more flexibility and can help minimise transaction costs during periods of low market volatility.
Choosing the right rebalancing frequency for your portfolio depends on your individual circumstances and preferences. Annual rebalancing is generally the best way to go for long-term investors, but you may choose to incorporate a threshold into your strategy for exceptional circumstances. In the next section, we’ll explore the different rebalancing strategies available to UK investors and how to implement them effectively.
Portfolio Rebalancing Strategies
Manual rebalancing
- Pros and cons: Manual rebalancing involves actively buying and selling ETFs to bring your portfolio back to its target asset allocation. The main advantage of this approach is the level of control it offers, as you can decide exactly when and how to rebalance your portfolio.
- Step-by-step guide: To manually rebalance your portfolio, start by calculating the current value of each asset class and comparing it to your target allocation. If an asset class has deviated significantly from its target, buy or sell ETFs to bring it back in line. Use the portfolio rebalancing calculator at the top of this article to work out what you need to buy and sell to bring your investments back in line. Be mindful of transaction costs and tax implications when executing your trades.
Automatic rebalancing
- Pros and cons: Automatic rebalancing is a service offered by some investment platforms that automatically adjusts your portfolio to maintain your target asset allocation. The main advantage of this approach is convenience, as it saves you time and effort. However, automatic rebalancing may come with additional fees, and you may have less control over the timing of your trades.
- UK platforms offering automatic rebalancing: Several UK investment platforms offer automatic rebalancing tools for ETF investors. It does make life easier, but the portfolio rebalancing calculator at the top of the article simplifies the manual process.
Tax considerations for UK investors
- Capital gains tax: When rebalancing your portfolio, you may realise capital gains or losses from selling investments. If you realise gains over the tax-free threshold, you’ll need to pay CGT. See our guide to ETF tax for up to date details. It’s important to keep track of your realised gains and losses and factor them into your rebalancing strategy.
- Bed and ISA strategy: UK investors can use the “Bed and ISA” strategy to minimise capital gains tax when rebalancing their portfolios. This involves selling ETFs and immediately repurchasing them within an ISA wrapper, effectively sheltering future gains from tax. However, this strategy may incur additional transaction costs and should be carefully considered in light of your individual circumstances.
When deciding on your rebalancing strategy, it’s crucial to consider the transaction costs involved. Frequent rebalancing can lead to higher trading fees, which can eat into your returns. If your portfolio’s asset allocation is close to your target, you may consider skipping a rebalancing event to save on transaction costs. For example, if your annual rebalance would only involve minor adjustments, it may be more cost-effective to wait until the following year or until your portfolio has deviated further from its target allocation.
In the next section, we’ll walk through an example of rebalancing a portfolio to illustrate the process and its potential benefits.
Example of Rebalancing an ETF Portfolio
Example portfolio: Let’s consider an example two ETF portfolio with an initial investment of £100,000 and a moderate risk profile. The target asset allocation is 60% stocks and 40% bonds, which is achieved using two ETFs:
- Vanguard FTSE All-World UCITS ETF (VWRP) for the equity portion
- Vanguard UK Government Bond UCITS ETF (VGOV) for the bond portion
The initial portfolio looks like this:
- VWRP (60%): £60,000
- VGOV (40%): £40,000
Fast-forward one year, and suppose the stock market has performed well, while bonds have remained relatively stable. The portfolio’s value has increased to £110,000, but the asset allocation has drifted:
- VWRP (65%): £71,500
- VGOV (35%): £38,500
To rebalance the portfolio back to the 60/40 target allocation, you would need to sell some of the overweight asset (VWRP) and buy more of the underweight asset (VGOV). The rebalanced portfolio would look like this:
- VWRP (60%): £66,000
- VGOV (40%): £44,000
To achieve this, you would sell £5,500 worth of VWRP and use the proceeds to buy £5,500 worth of VGOV.
Comparing portfolio performance with and without rebalancing
Let’s compare the performance of the rebalanced portfolio to a scenario where no rebalancing was done. Assume that in the following year, the stock market experiences a correction, while bonds remain stable. The non-rebalanced portfolio might look like this:
- VWRP (55%): £60,500
- VGOV (35%): £38,500
- Total value: £99,000
In contrast, the rebalanced portfolio would have been better positioned to weather the market correction:
- VWRP (55%): £60,500
- VGOV (40%): £44,000
- Total value: £104,500
This example illustrates how regular rebalancing can help manage risk and potentially improve long-term returns by maintaining your desired asset allocation.
Of course, this is a simplified example, and actual results will vary depending on market conditions and the specific investments in your portfolio. Nonetheless, it demonstrates the potential benefits of a disciplined rebalancing strategy.
In the next section, we’ll discuss some common mistakes to avoid when rebalancing your portfolio.
Common Mistakes to Avoid
Rebalancing too frequently: While rebalancing is essential for maintaining your desired asset allocation, doing it too often can be counterproductive. Frequent rebalancing can lead to higher transaction costs, which can eat into your returns over time. Moreover, rebalancing too frequently may prevent your investments from benefiting from long-term market trends. Stick to your chosen rebalancing frequency, whether it’s annual, quarterly, or based on a predetermined threshold.
Ignoring transaction costs: Transaction costs, such as brokerage fees and bid-ask spreads, can add up quickly when rebalancing your portfolio. Ignoring these costs can significantly impact your overall returns, especially if you have a smaller portfolio or rebalance frequently. Always consider transaction costs when deciding on your rebalancing strategy and frequency. Look for UK investment platforms that offer low-cost or commission-free trading to minimise the impact of transaction costs on your returns.
Deviating from your asset allocation strategy: Your asset allocation strategy is designed to align with your risk tolerance and investment goals. Deviating from this strategy during the rebalancing process can undermine its effectiveness. For example, if you decide to overweight a particular asset class because of recent strong performance, you may be inadvertently increasing your portfolio’s risk. Stick to your predetermined asset allocation targets when rebalancing, and avoid making emotional decisions based on short-term market movements.
Trying to time the market: Attempting to time the market by delaying or accelerating your rebalancing schedule can be tempting, especially during periods of market volatility. However, trying to time the market is notoriously difficult, even for professional investors. Stick to your rebalancing plan regardless of market conditions, as this disciplined approach will help you maintain your desired risk level and potentially capture long-term market gains.
By avoiding these common mistakes, you can implement a more effective and efficient rebalancing strategy, ultimately supporting your long-term investment success.
Conclusion
Portfolio rebalancing is an important part of successful long-term investing. By regularly adjusting your portfolio to maintain your desired asset allocation, you can effectively manage risk, potentially enhance returns, and ensure that your investments remain aligned with your goals and risk tolerance. The portfolio rebalancing calculator above will help with the calculations, letting you know exactly what you need to buy and sell to bring your investments back in line.
Your rebalancing plan should consider your risk tolerance, investment timeline, and the costs you’ll incur. Whether you choose to rebalance manually or use automatic rebalancing tools offered by investment platforms, the key is to remain disciplined and consistent in your approach.
