How to review and rebalance your Isa portfolio

Chris Barrett: If you tend to panic during market declines, you should consider a more conservative asset allocation

Chris Barrett is the investment director at wealth management firm JM Finn.

Asset classes such as stocks, bonds, cash, property, and alternatives like gold, are interconnected yet differ in terms of their exposure to global risks.

They tend to have little or low correlation, meaning that the performance of each asset class is (more or less) independent of the others.

There are three steps to take when managing the asset allocation of your portfolio, and several further important tips to remember.

1. Set a target asset allocation

Creating the right asset allocation involves many elements but focuses mostly on your ability and your willingness to take risk.

One’s ability to take risk depends upon factors such as age, employment status, dependants and level of savings.

This differs to one’s willingness to take risk which depends upon factors such as risk tolerance, past experiences and trust in the financial system.

Typically, investors would be advised to be prudent when judging their ability to take risk.

Risk can always be added to a portfolio should the investor’s appetite for it increase, but it is much more difficult to reduce risk given the conversations about doing so typically occur following market downturns, which historically have been the best opportunities to increase risk.

As a basic guide, if you tend to panic during market declines, such as in March 2020, or throughout 2008-2009, or if you’ve ever sold a loss-making investment that you planned to hold for a long time, you should consider a more conservative asset allocation, regardless of your age.

Research by many investing experts over the years suggests that on average equities return around 7 per cent a year through a combination of dividends and capital growth over the long term.

However, the volatility in these returns is substantial.

Therefore, clients who have short-term investment horizons or have a low risk tolerance should be particularly prudent with their allocations into the equity market, and typically should have a modest exposure if their time horizon is under five years.

A greater allocation to less risky assets such as bonds or alternatives might prove sensible in this situation.

It might be practical to delegate elements of your asset allocation to sector specialists by investing in actively managed funds.

Whilst the fees might be higher than for passive tracker fund alternatives, active managers will be making their own decisions as to how to allocate capital within their remit.

Using their expertise is therefore less burdensome for individual investors who may lack the knowledge and desire to implement and manage the strategy themselves.

Benchmarks such as the PIMFA Private Investor Indices can help to guide asset allocation decisions, as these are representative of a diversified global multi-asset portfolio. 

2. Review your portfolio’s current allocation

Once you know your ideal asset allocation, it’s time to figure out where your investments currently stand.

Most investment accounts will include this information as part of their online dashboard.

If you invest in funds, you’ll need to research their holdings, which can be found on their factsheets or via an investment research site.

Once this is done you are likely to arrive at a difference between your existing allocation and your target, and this will help you to identify areas in which you are ‘overweight’ and ‘underweight’ in comparison to your desired level. 

3. Rebalance through transactions

As markets fluctuate, your allocation will likely fall out of balance.

This might apply to geography in just the stocks portion of your portfolio, as well as between different asset classes.

For example, if you had a global multi asset portfolio between 2017-2020 you would have noticed some notable differences in the performances of your allocation to US assets in comparison to UK assets.

US equities outperformed their UK counterparts quite significantly during this period.

If your portfolio was left untouched, the performance of the US element of the portfolio will have led to an increase in the overall weighting to US assets, such that the portfolio is ‘overweight’ US equities and ‘underweight’ UK assets.

In this scenario, if an investor wishes to maintain their long term asset allocation, they must rebalance their holdings. 

What other tips should you remember

– Through diversification, investors can enhance returns for the same level of risk, or reduce risk for the same level of return.

– The most important step of the process is setting a sensible desired asset allocation from the outset. This will be the most influential factor in determining the performance of your portfolio over the coming years, so it is best to ensure you have confidence in your long term strategy.

Market watch: How to ensure shares, bonds and other holdings don’t drift off target as prices fluctuate

– If you are not confident in your abilities there is no shame in seeking advice from experts who can guide you along the way.

– Different asset classes have each had years in which they outperform each other.

– Assets within the same asset class often perform differently due to their geography, and variability of returns within a single asset class can be significant.

– The best performing asset class in a calendar year is highly unlikely to be best performing asset class in the following calendar year.

– Rebalancing too often can negatively impact returns due to the effect of transaction costs. Investors who tend to monitor their portfolios religiously often get led into making suboptimal decisions.

– It might be best to review on a quarterly or semi-annual basis, or after any major shifts in markets, so that the temptation to adjust and rebalance is limited to these occasions.

– Don’t be afraid to do nothing. It may seem counter intuitive but if your portfolio has been organised appropriately and remains akin to your long term asset allocation, the best thing to do is often nothing.

This post first appeared on Dailymail.co.uk