When you first meet your advisor, you’ll provide all your financial details (yes, this can be daunting) and discuss your short, medium and long-term objectives. You’ll also be asked about your attitude to risk, to determine your individual risk profile. Armed with this information, your advisor will allocate your funds to a selection of appropriate assets, each with their own risks and expected returns.
Having all your ducks in a row on Day One doesn’t mean they’ll stay there as time passes. Because assets very rarely perform exactly as expected, your asset allocation will almost certainly diverge from your initial objectives over time. In the same way that a yacht has to change course according to the winds, you need to rebalance your portfolio – with the help of your advisor, of course.
Switching, also referred to as rebalancing, is the practice of periodically re-aligning your asset allocation with your original or revised objectives.
The most important benefit of rebalancing is that it keeps your asset allocation aligned with your time-based investment goals and risk profile.
Without rebalancing, you may well end up taking on too much risk – all very well in a bull market, but a recipe for disaster when the markets turn and for some reason you need to access the funds. By the same token, if your portfolio becomes too conservative, it’s likely that you won’t achieve your long-term objectives, such as saving for retirement.
Switching does involve selling a portion of your investments and Capital Gains Tax (CGT) will apply if the investment has gained value. BUT, importantly, rebalancing allows you to benefit from the R40,000 CGT exclusion every financial year. This means that your base cost is continually reset at a higher level which assists in reducing your CGT liability on future sales. This also helps in minimising CGT after your death, thus leaving more for your loved ones.
What’s more, CGT is not applicable when rebalancing retirement funds such as retirement, life and living annuities.
One of the perceived disadvantages of rebalancing is that you can cut the legs out from under an asset class before it has finished its bull run. But what you’re really doing is managing the risk of your overall portfolio.
The very thought of CGT is enough to put some people off the rational need for changes in allocation. As mentioned, rebalancing out from a portion of your portfolio constitutes a sale and the gain is subject to CGT. Luckily only 40% of the gain is added to your income and there’s the exemption on the first R40,000 of gain during each financial year. Do remember that the R40,000 relates to gains on the sale of all assets, including property and businesses.
Granted, the process can (and often does) feel like a maintenance chore. To which the obvious rebuttal is that it’s time well spent – this is your financial security we’re talking about, after all.
If your investment account is held on one of the LISP platforms, we’ll ask you to sign a rebalance form which changes the percentage allocation of each investment relative to the entire fund.
You can also rebalance when making additional contributions to or withdrawals from your investments. If you have additional funds to invest, you could (depending on your circumstances) buy more of the investments where there’s potential for growth. If you need to withdraw funds, simply sell some of the investments which have overperformed and lock in the gain.
Think of rebalancing as a systematic way of resourcefully rebalancing your strategic asset allocation and staying true to your goals. Put bluntly, failing to make changes in your portfolio will increase your exposure to risk without increasing your potential returns. Have we convinced you yet?
Please call us to discuss the asset allocation of your investments and the opportunity to rebalance for the better.
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