Smart Portfolios 8 – Rebalancing
Today’s post is our eighth visit to Rob Carver’s book Smart Portfolios.
Rebalancing
The fourth and final part of Rob’s book is about rebalancing.
There are three reasons for rebalancing:
- periodic correction of portfolio drift
- a change in your target allocations
- changing volatilities or correlations
- since we are using very long-term values for these, we should not need to make changes very often, if at all
The fourth reason for rebalancing would be to overlay Rob’s return forecast rules (for Cutting costs
Rob approaches the costs of rebalancing by looking at the annual portfolio turnover implied by various rebalancing strategies. To keep trading costs down, Rob offers two approaches. The first is the no-trade zone. Rob suggests a 2% buffer (1% in each direction away from ideal), but my instinct would be to use half of the minimum allocation size in the weighting plan. Later on, Rob suggests that half of the average allocation is the best size. A third approach (which I actually use) is a minimum trade size. Not also that rebalancing costs are lower (as an annual percentage) for larger portfolios, as larger trades are more efficient. Rob suggests that annual rebalancing is enough for private investors. When a new (previously unavailable) fund appears, Rob compares the weight he would allocate to it to the no-trade zone and the minimum trade size. He also provides a table for working out the breakeven level for switching to more diversified funds. As before, Rob spreads the up-front costs over twenty years, which I think is optimistic. Most UK investors should by now – more than 30 years after PEPs / ISA were introduced, and 13 years from the simplification of SIPPs – have a substantial proportion of their investments within tax shelters. In addition, we have an annual CGT allowance of £12K (from April 2019) which means that even taxable accounts offer some protection. Dividends have a less favourable treatment. The UK has few “taper” laws in the investment arena, unlike the US. Nevertheless, tax should only be a consideration for the largest investors. Rob’s advice is to net off losses against gains and to add any tax to be paid into the calculations of whether substitutions are worthwhile. It’s important to keep the actively traded part of your portfolio – and volatile and/or high yielding equities = within a tax shelter. You can also “mirror” holdings in shelters and taxable accounts, selling in the shelter on a gain and in the taxable account on a loss (which can then be offset against other gains). The final chapter of Rob’s book is aimed at readers who have realised that their existing portfolio looks nothing like Rob’s recommendations, and that radical change is required. He sets out the key steps in order of priority: Of course, for all of these steps, the cost of changing needs to be compared to the benefits. I would personally find steps 1 and 2 difficult to implement before I had worked out steps 3 to 5. Rob uses the example of a portfolio he set up for his mother, then neglected and later had to fix. And that’s it – we’ve finished Rob’s book. It’s made me think hard about my asset allocations and has led to the recently-published series of posts about “The Perfect Portfolio”. I’ll be back in a couple of weeks with a monster post pulling together all of the lessons from Rob’s book. Until next time. Share this with Twitter, Pinterest, LinkedIn, Tumblr, Reddit, StumbleUpon and WhatsApp. Article credit to: https://the7circles.uk/smart-portfolios-8-rebalancing/
Tax
Portfolio repair
Conclusions