Our Slow and Steady model portfolio [1]was especially designed to minimise costs and hassle for small, passive investors right down to its rebalancing strategy. But how exactly does that strategy guide our new purchases?
[2]
The Slow and Steady portfolio is rebalanced [3] as a matter of course on a quarterly basis with cash from new contributions.
So every three months, fund purchases are automatically calibrated to return the portfolio to its target asset allocation [4]:
- UK equity: 20%
- Developed World ex UK equity: 50%
- Emerging market equity: 10%
- UK gilts: 20%
N.B. Developed World ex UK equity is split between four funds (due to the lack of a single, no-trading fee fund in the UK) as follows:
- North American equity: 27.5%
- European equity ex UK: 12.5%
- Japanese equity: 5%
- Pacific equity ex Japan: 5%
- Total: 50%
Rebalancing is the act of pruning back your risk. Without it the portfolio could mutate into a much hairier beast if, for example, the emerging markets fund went on the rampage. Over years, the portfolio could end up with a much higher percentage of its value bound up in this risky asset class than the envisaged 10%, if we did stood idly by.
So when it’s time for the portfolio’s quarterly £750 new contributions, we buy more of the under-performing funds and less of the out-performers, and take advantage of mean reversion [5].
Rebalancing slo-mo replay
The first time the Slow and Steady portfolio was rebalanced its market value was £3,017.84
It’s important that the rebalance takes into account the new cash added, so:
£3,017.84 + £750 = £3,767.84 (total portfolio value after drip-feed)
How much of this total should then be allocated to each asset class?
A quick example should do the trick. The target allocation for UK equity = 20% of £3,767.84.
£3767.84 / 100 = 37.6784
37.6784 x 20 = 753.568
So we want £753.57 of UK equity in the portfolio once the new cash is added.
The value of UK equity in the portfolio prior to the new cash = £607.10
£753.57 – £607.10 = £146.47
£146.47 is the amount of UK equity we should buy to ensure the asset is rebalanced to its target allocation of 20%.
That calculation is repeated for each fund in the portfolio to determine how much of each asset class we need to buy.
Eventually the portfolio will grow too big to be entirely rebalanced by new cash. At that point we’ll need to sell assets that exceed their target allocation and use the proceeds to pump up assets that fall short.
That won’t cause the Slow and Steady portfolio any trading cost pain though (the bane of rebalancing) because we’re cannily invested in index funds [6] that don’t trigger broker fees.
Take it steady,
The Accumulator