Portfolio management

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15. Rebalancing your portfolio

The balance of your portfolio will change constantly, even if you do nothing. Share prices will rise and fall. Dividends will trickle in. Some of your holdings may be taken over or - despite your best efforts at selection - go bust.

How should you respond to these changes? Your options are broadly:

1. Do nothing. Let the portfolio take care of itself
2. Aim to restore the balance each year, or fairly constantly, as you buy and sell
3. Impose upper and/or lower percentage limits. Let the portfolio fluctuate within those limits.

It should be said right away that this is a very tricky multiple-choice question, to which there is no straight answer. Active investors and traders will tend to take option (2). Their constant dealing will naturally lead them to rebalance their portfolios over time.

Imbalances are most likely to arise for investors with core holdings or trusts that grow to become a huge proportion of the portfolio, say one-third or one half.

This may sound more like a blessing than a curse. But such success carries risks. If your major holding runs into trouble and the share price halves, your portfolio will drop by 17-25%. That is a massive loss. To make it up, the portfolio will have to rise 20.5-33% from its new, reduced value. It might take you years to recover from such a setback.

Any sensible financial investor would tell you to lower this risk right away, by selling some of that holding and diversifying. It would be hard to fault this advice. But a big argument against it is that the wills of the wealthy often show their fortune was made by just one or two huge holdings. Likewise, Warren Buffett has scored above-average gains by occasionally placing up to 40% of his funds into exceptional stocks like Coca-Cola and American Express.

In the end, this is a matter of judgment. If you really know enough about a company to be confident of its future, you can afford to hold unusually large amounts of stock. Otherwise, you should not run the risk.

As a rule of thumb, play safe. Consider limiting any single holding (other than a tracker fund) to no more than one-third of your portfolio. Above that, start selling.

At the other extreme, less successful holdings may shrink to become an insignificant part of your portfolio. Say you have 10 shares and 9 of them rise by an average of 20%, while the price of the 10th falls 20%. That share now accounts for less than 7% of the total. It may be unlikely to do much for your future returns. You may probably do better to sell and reinvest the money where it may do more good. For example, you could buy more of your most successful share.

As a rule of thumb, be ruthless. Sell any single holding (other than recovery shares on which you have set a stoptime) once its value falls to less than 6-7% of your portfolio.

1. First things first 2. Should you invest before paying off your mortgage? 3. Do you want growth or income? 4. Diversification: summary 5. Diversification: Safe custody 6. Diversification: asset allocation 7. Diversification: shares 8. Diversification: sectors 9. Diversification: countries 10. Balancing your portfolio 11. What should you hold where? 12. Tips for married couples 13. Lump sum or drip feed? 14. The role of cash 15. Rebalancing your portfolio 16. What to do with dividends 17. All about bonds 18. What to do if you inherit a portfolio 19. Benchmarking performance 20. Setting up a portfolio spreadsheet 21. Conclusion

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