New year, new investments – time to rebalance your portfolio

Don’t let your holdings become unbalanced – set clear guidelines and a definite date for an annual review of your investment portfolio

(Image credit: AFP via Getty Images)

The start of the year always seems to be the sensible time to tidy up my portfolio. From speaking to other investors, I don’t seem to be alone in this – many of us think it’s good to do a spring-clean. Maybe that’s down to the atmosphere, or perhaps writing a cheque to the taxman helps focus our minds on money. But whenever you choose to do rebalance your portfolio, pencilling in a definite date once a year for a thorough review is an easy way to be a more organised investor.

Three steps to rebalance your portfolio

Begin by examining your overall asset allocation – ie, the split between different assets such as stocks, bonds, cash and gold. You should have a target asset allocation in mind that seems appropriate for your circumstances – for example, 60% shares, 20% bonds, 10% cash and 10% gold for a simple balance between growth and defensive investments – and see how far your portfolio deviates from it. You may then decide to get back to your target asset allocation by adjusting how much new money you put into each asset class in the coming year, or you may be able to do it immediately when you look at your individual holdings.

Start the second step with some guidelines for what proportion of your portfolio each fund or stock or bond can make up. This will vary: it may be safe to have 10% in a single diversified fund, but having 10% in a single stock may bring too much risk. If some investments are far above or below their target level, you may want to rebalance them, but be pragmatic: there may be little point in incurring the costs of bringing a 9% position back to a 10% target, for example. Finally, look for holdings where the investment case has changed – often those that are sitting on big gains or large losses. Ask if you would still buy them today. It’s often more comfortable psychologically to take profits on a winner than to sell a loser, so scrutinise ones that you are still holding in the faint hope that they will recoup some of their losses. Following a rule of cutting your loss at a certain level, 20% or 30%, say, can be helpful.

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Three tools to make things easier

A spreadsheet such as Microsoft Excel or the free online Google Sheets application is more than sufficient for these calculations. That said, if you want to analyse your portfolio in more detail, consider specialist programs such as StockMarketEye, Investment Account Manager and Fund Manager. You certainly don’t need these, but if you want to keep a close eye on your successes and failures – and have a better idea of whether your decisions are really adding alpha (see below) – they can be very useful tools.

I wish I knew what alpha and beta were, but I’m too embarrassed to ask

Alpha is the amount of value an investor adds or takes away from an investment portfolio.

In other words, it measures how their stock- or asset-picking skills affect the portfolio, above and beyond any returns that are simply down to what you’d expect from the performance of the market as a whole.

Alpha can be looked at in two main ways. The first is simply to compare the portfolio’s performance with a benchmark index. So the returns on a portfolio of UK shares might be compared with the returns on the FTSE All-Share index over a given time period. If a fund manager’s portfolio has returned 15% compared with 10% for the benchmark, then the manager has generated positive alpha of 5% on this simple measure.

Of course, the manager might be taking more risk than the overall index (for example, by only investing in small companies). More in-depth ways of looking at alpha take this into account. One measure known as Jensen’s alpha compares a portfolio’s risk-adjusted returns with what a financial model called the capital asset pricing model (CAPM) predicts it should achieve. So if CAPM predicts a portfolio return of 17% in the example above, but the manager made 15%, then they had negative alpha of 2% (ie, they did worse than they should have done considering the composition of the portfolio).

Beta is a way of measuring the risk of a share or a portfolio compared with the risk of the market as a whole. A share with a beta of one will move roughly in line with the stockmarket. A beta of more than one suggests that a share rises and falls in line with the direction of the market, but by a greater amount. A beta of less than one indicates a share that is less volatile than the market (or an investment that does not consistently move in line with the market, even though it may still be volatile). Beta is one of the key inputs into the CAPM and similar models.

Cris Sholto Heaton

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.