How to track your performance and rebalance your portfolio

WE have focused in previous weeks on how to kick start your investment journey, covering the basics on various asset classes and the benefits of diversifying your investment portfolio.

Setting up your portfolio is just the beginning. Maintenance is necessary to ensure your portfolio meets your investment objectives. This brings us to our next topic: tracking performance and rebalancing your portfolio.

Tracking performance

Tracking and evaluating your portfolio can draw your attention to potential performance issues or unintended investment risks. You can then take corrective action earlier.

To track performance, you should measure the portfolio's change in value over periods of time.

Naturally, investors would want to achieve a positive return every year and as large a return as possible. But for effective tracking there are several important considerations beyond headline returns alone.

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• Annual returns

Consider tracking returns both annually and cumulatively, as the annual and cumulative returns tell you different things about your performance.

From the example in the table, we see that the portfolio has a cumulative return of 30 per cent. This ought to go up gradually over the years, although it may occasionally dip due to economic or market conditions.

The cumulative return can be benchmarked against your expected return. If your cumulative return is below expectations, you may want to take more risk for a higher return. If this is not an option, you will need to increase your investment levels if you hope to accomplish your objectives.

The annual return, meanwhile, shows the portfolio performed better in year three than in year two. But before you assume that you are getting better at investing, compare your annual return with a benchmark. If your portfolio is made up 100 per cent of global equities, for instance, compare it to a global stock benchmark such as the MSCI All Country World Index. If in year three the index gained 50 per cent, then you are underperforming with an 18 per cent return and you may need to adjust your portfolio.

• Comparative returns

Don't just benchmark your portfolio as a whole, though. That can make it difficult to figure out exactly how to make adjustments. You should also track annual returns for sub-sections or even individual components of your portfolio.

For instance, you may want to compare how your Singapore stocks collectively performed against the Straits Times Index. If you have bought units in a bond fund then you would want to track that fund's performance against its benchmark.

Besides adjusting your portfolio to ensure it is performing optimally based on cumulative and comparative returns, you will also want to adjust your portfolio to make sure you have the right balance of assets. That's because your portfolio asset mix changes as different assets perform differently. To bring things back to your desired asset allocation, rebalancing is needed.

What is rebalancing?

In earlier weeks, we touched on how diversifying your portfolio - by allocating weights to different asset classes - can help meet different investment goals.

While you may have started with an ideal weightage, asset prices are not static. If a portfolio is simply allowed to drift with the market, an investor would see riskier assets start having a higher weightage.

Take an example of an equally-weighted portfolio. In an equity bull market, stocks rapidly gain in value while bonds remain relatively stable.

This could result in stocks taking up, perhaps, two-thirds of your portfolio - instead of the desired 50 per cent. Your portfolio's risk increases, partly because equities tend to be more volatile and partly because after a long period of outperformance there is greater potential for a slight downward adjustment.

To bring the portfolio back in line with your risk and return objectives, you would need to sell some stocks to buy bonds. This is what it means to rebalance your portfolio.

Alternatively, you can also invest fresh capital into underweighted asset classes to restore the balance.

Why is it necessary?

It seems counterintuitive to sell stocks that have done well. Continuing to ride with winners usually seems like the better idea.

But even if there is room for further appreciation among your winners, there is also a greater risk of corrections. Taking profit off the table and diversifying into other assets can leave the portfolio stronger.

You will be reducing your concentration risk, mitigating the likelihood of large fluctuations.

The economic cycle also normally sees different assets performing well at different points in time. By rebalancing and rotating out of assets that have done well, you are selling at a high point and putting money in areas better-placed to capture the next phase of growth.

You would also potentially avoid a scary and costly situation in which you panic and sell your shares during a market correction.

Rebalancing in accordance with set rules instills discipline and removes emotions from investing. But it is also important to not blindly rebalance and put money in underperforming assets that have been assessed to be bad investments.

Also, you do not always need to rebalance back to your starting point. As you get older, for instance, you will naturally want to change the weights of certain assets in your portfolio. Rebalance to meet your objectives, but also review your objectives each time.

Approaching rebalancing

There are several ways to approach rebalancing.

• Calendar rebalancing

A popular option is calendar rebalancing, which involves adjusting your portfolio at fixed periods. You can decide on the frequency - monthly, quarterly or annually.

One benefit of calendar rebalancing is that you do not have to constantly monitor the market.

But there would be a risk of your portfolio straying significantly from its strategic asset allocation between rebalancing dates.

• Percentage-range rebalancing

In this method, rebalancing is triggered by changes in your portfolio value. You first set an acceptable range of fluctuations for each asset class from their ideal weights, such as +/- 5 per cent.

Again assuming an equal weighted portfolio with four asset classes as per the graphic, if emerging markets are booming and the weight of such equities in the portfolio rises to over 30 per cent that would trigger a rebalancing. This method is more responsive, but requires constant monitoring.

The range you set would depend on various factors, including transaction costs and your risk tolerance.

It would not make sense to have a very narrow range that requires constant rebalancing, as this also comes with transaction costs. If your risk tolerance is higher, you may also be willing to have a wider range of fluctuations.

Keeping track of your portfolio performance and ensuring that each asset class falls within required weightings will help ensure that your portfolio will continue to meet your investment objectives over the long term.

• This is the final instalment of Invest & Grow, a weekly 10-part series that aims to help new investors get started on their investment journey.