Deciding when it’s time to rebalance a SMSF

A sense of balance is a tremendous attribute to have as an investor.

For share investors, last month has been akin to a surfer turning up at a long-term favourite beach to see waves that offer appealing rides one minute and are downright scary the next.

Dramatic price plunges followed by record rebounds are the sort of thing you might enjoy at the movies or the racetrack but would rather not see played out in your portfolio.

A sense of balance is essential for people wanting to avoid falling into the trap of making short-term decisions driven by emotion rather than long-term investment strategy.

Looking for a sensible perspective on the market gyrations this week, it was a good time to remember the words of one of the great investment thinkers of the past 100 years - Benjamin Graham.

Graham said "in the short-run the stock market behaves like a voting machine, but in the long term it acts like a weighing machine" (i.e. its true value will in the long run be reflected in its stock price).

We have seen the voting machine in full flight last month.

During rebound Tuesday, what was changing in the underlying businesses of our major banks or our major mining companies? The obvious answer is nothing, except investor sentiment - primarily driven from offshore - had shifted significantly and investors were looking to trade out of risk.

Recent market volatility is a strong test for even the most balanced of investors. Doing nothing goes against almost every behavioural instinct we are hard-wired with. Yet that may well be the best approach for people who have a well-diversified portfolio that lines up with their individual risk profile.

It is also a time when the discipline of having a written financial plan can prove an invaluable navigation tool. Being able to pull the long-term financial plan out of the filing cabinet - or perhaps sitting down with your financial planner and doing a portfolio review - can help remind you of the long-term course you set in a less frenetic time.

Certainly markets may have blown things off course in the short-term, but the key question to answer is: has anything fundamentally changed in terms of your goals or portfolio risk levels? If it has, then perhaps it is time for a portfolio review and a rebalance.

Rebalancing your portfolio is often underrated - both in terms of the need to do it and the degree of difficulty in putting it into practice. It is also one of the clear differences between so-called "professional" investors like super fund investment committees or trustees and individual investors. Super fund investment committees do have one clear advantage - regular cash flow from super guarantee contributions that enables them to divert cash into the asset class that is out of the asset allocation target ranges.

For individual investors, rebalancing a portfolio can have tax consequences if it means selling out of one asset class to buy more of another, so if it is possible to use cash flow in a sensible way - particularly for investors with a self-managed super fund - that removes one of the hurdles to effectively managing the rebalancing process.

A critical argument for regular rebalancing is that it keeps the risk level of your portfolio within the bounds that you are comfortable with. That said, do not underestimate the emotional challenge of sticking to a rebalance plan.

Good asset allocation practice is to set realistic tolerance ranges for the respective asset classes. For example, this may mean setting a tolerance level around plus or minus 3 per cent to allow room for normal short-term market movements. If the band is set too tight, you may trigger excessive short-term trading to stay within the target allocations.

In August 2011 a portfolio review was more than likely to show that the respective movements of growth assets like shares and defensive fixed interest assets had moved outside asset allocation weights, potentially triggering the need to rebalance given that the sharemarket was down around 10 per cent in the year to date. Rebalancing in this case would mean either investing new cash flow into shares or selling down fixed interest securities to provide the funds to rebalance with. This is where rational investment approach meets emotional behaviour influence head on.

Rebalancing restores your portfolio balance - and most importantly keeps risk levels in line with your long-term objectives - however, you can see the emotional challenge that needs to be overcome to do that. Selling winners to buy losers is a disciplined act, not one that will give you a warm inner glow.

This is why at times like these a dispassionate third party like a trusted financial adviser can play the valuable role of financial "coach" to help keep the focus firmly on the long-term and be a steadying influence ensuring that balance is maintained.

Robin Bowerman is the principal of corporate affairs and market development at Vanguard Investments Australia.