In November 2017 we increased the allocation to government bonds and gold in all of the Stockspot portfolios. This higher allocation to defensive assets has helped to cushion portfolios during the recent market volatility related to Coronavirus.
Gold has now risen 38% over 12 months compared to Australian shares which have fallen 14%.
As a result of these market moves, the gold component of many client portfolios has risen from 12.3% initially to as high as 17-20%. On the other hand, the Australian shares component has fallen.
This has led to a rare opportunity to ‘rebalance’ some client portfolios to get them back towards their target investment mix.
To do this we’ve generally been selling some Gold and buying some Australian shares.
It may seem counterintuitive that we would be selling a defensive asset like gold and investing the proceeds into shares during a period of market turmoil. Rest assured that this is exactly what should be happening in order to get your portfolio risk back to its target risk level and take advantage of the low prices.
Why do we rebalance?
When you start investing with Stockspot your initial portfolio allocation has a certain percentage in defensive assets like bonds and gold, as well as growth assets like shares.
During the recent market volatility, defensive asset values have risen while share markets have fallen. This has led to the defensive part of your portfolio becoming larger as a proportion of your overall portfolio. Your portfolio has now become ‘too defensive’. This has helped to protect your portfolio as the market has fallen, but left unchecked will mean that you miss out on returns when share markets rise again.
To address this, we’ve been automatically ‘rebalancing’ some client portfolios by selling some defensive assets, using that money to invest into shares. This is a buy low – sell high strategy. You’ve sold defensive assets (gold or bonds) at relatively high levels and purchased growth assets (shares) at low levels to get your investment mix back to where it should be.
Why would you sell gold after it returned 38%?
While it may feel like the wrong thing to be doing at the moment, rebalancing out of assets that have performed well is important over the long run to keep your portfolio risk balanced. Keep in mind that our system waited for share markets to fall by around 30% and gold to rise by more than 30% before rebalancing most portfolios. This means that the defensive part of your portfolio has provided significant protection while share markets have fallen.
It’s important to note that when we rebalance we don’t sell all of your defensive assets, just a small amount of them. You still own the right amount of them for your investment horizon and risk capacity.
Vanguard recently reported in its “Economic and market outlook 2020” that periodically rebalancing your portfolio in this way can add 0.91% per year in returns to your portfolio.
Does this mean you think share markets will rise now?
It’s absolutely possible that share markets could fall further before they rise. As we wrote in our recent article around Coronavirus:
The news may get worse before it gets better as the mortality increases and governments bring into place measures to contain the virus. On the other hand, confidence could bounce back if infection rates start to fall and governments and central banks take swift action.
Rebalancing isn’t about trying to time your entry into the market or pick the perfect entry point. It’s about ensuring your portfolio is taking the right amount of risk for your investment horizon.
You don’t want to rebalance too often otherwise you’re incurring too many costs. On the other hand, you don’t want to wait too long or you might miss your opportunity to take some profits from assets that have risen.
The goal is to rebalance “often enough, but not too often.”
We typically rebalance when an asset has moved between 20-30% away from its target allocation which is consistent with industry best practice.
Rebalancing can also help smooth out your returns over longer periods of time to minimise volatility and optimise returns.
Why do you automate the rebalancing process?
Rebalancing is counterintuitive.
It’s hard to sell things that have done well because it involves going against the crowd. It’s also difficult to convince yourself to buy the investment that has performed poorly and everyone is probably telling you to avoid.
Automated rebalancing removes emotion and helps you to buy investments when they’re low and sell when they’re high. It’s one of the big advantages of using an automated wealth service like Stockspot rather than doing it yourself.