Sound investing is about having the right investment strategy. It’s not about short-term tactical trading or speculative trend-chasing.

However, there may be good reason to periodically reassess your investments by ‘rebalancing’ your portfolio. This means ensuring the balance of shares and bonds in your portfolio is still in line with your goals and attitude to risk.

But why is rebalancing important?

Research has shown that it is your mix of assets that will have the greatest impact on your long-term investing success¹. You need the right balance of shares and bonds to enable your savings to work as hard as possible over several years, if not decades. The exact balance will depend on your goals, investing timeframe and attitude to risk.

Time is of the essence

The further away your goals are, the more you should consider having in shares relative to bonds. And vice-versa. History shows that shares tend to generate higher returns than bonds over the long term (periods of 10 or more years). But they are also more likely to jump up and down in price. This can leave you more exposed in a stock market downturn and the value of your investments could go down.

The more time you have, the more easily you should be able to ride out stock market dips. It’s why, if someone is close to retirement, they should probably consider holding more bonds in their investment portfolio. 

The one proviso is that some people are more cautious than others and may be less willing to take risks with their money. Your approach needs to be finessed based on your personal risk preferences.

But why the need for re-balancing? The reason is that different types of investments tend to behave differently to one another. If some investments perform better than others, then the ratio of shares to bonds in your portfolio will inevitably change too. 

Let’s imagine you’re targeting a portfolio made up of 60% shares and 40% bonds. If your stock market funds grow by 10% on average in value one year, while your bond funds slip by 10%, then the split will change to something more like 65% shares and 35% bonds. You’re now inadvertently ‘overweight’ shares and ‘underweight’ bonds.

The change might seem small but, if left unchecked, this drift away from your original allocation can build over time. The diagram below illustrates the rebalancing process.

How rebalancing works

Source: Vanguard.

Redress the balance

If, in the original example, you wanted to get your portfolio back on target you could consider selling some of the strong-performing stock market funds and reinvesting the money in bond funds. Another way to redress the balance would be to direct any new cash contributions to those fund holdings that have underperformed.

That might seem counterintuitive to a lot of people. In my experience as an adviser, clients would often balk at the suggestion of adding to assets that were falling in value at the expense of their best-performing investments.

However, the objective of portfolio rebalancing is to maximise long-term returns while ensuring you don’t stray too far from the target mix of shares and bonds that you are comfortable with. This can be a difficult message to get across when stock markets are doing well, but it will protect you when markets go down.

In other words, rebalancing can help you stay disciplined and avoid making costly mistakes. The most successful investors are often those with discipline – those who stick to an investment plan and revaluate it regularly to ensure it stays aligned to any changes in their goals, situations or stage in life.

That’s why our all-in-one multi-asset funds – our LifeStrategy funds and our Target Retirement Funds – do the rebalancing for you. 

It’s also why our managed service for those investing via our individual savings account (ISA) or personal pension selects funds based on your attitude to risk and rebalances your portfolio to keep you to the right risk level. If the mix of shares and bonds in your portfolio drifts by more than 5 percentage points, we’ll rebalance the portfolio back to the target allocation. And if you add £100 or more, we’ll invest that new money in the most efficient way. For example, if US shares have fallen in valaue, we would buy more US shares with the new money. That way, we also maintain the right balance across different regions of the world.

¹ Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, 1995. "Determinants of portfolio performance." Financial Analysts Journal 51(1):133–8. (Feature Articles, 1985–1994.)

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

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The eligibility to invest in either ISA or Junior ISA depends on individual circumstances and all tax rules may change in future.

The Vanguard Target Retirement Funds and Vanguard LifeStrategy® Funds may invest in Exchange Traded Fund (ETF) shares. ETF shares can be bought or sold only through a broker. Investing in ETFs entails stockbroker commission and a bid- offer spread which should be considered fully before investing.

For further information on risks please see the “Risk Factors” section of the prospectus on our website.

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