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Rebalancing and reinvesting – why they matter

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If you’re getting started with investing, it’s important that your investments don’t get ‘unbalanced’, which is where you have too much money invested in one asset. Find out how this works.

Rebalance and reinvest
Although many investment articles talk about spreading your risk around, not so many discuss the concept of ‘rebalancing’ your investments, so it may not be an idea you’re familiar with. This is how it works:

  • Rebalancing simply means selling off some of your investments and buying others. The concept probably seems counter-intuitive when you realise what’s involved, but the idea behind it is a sound one.

For example, figures from investment platform Nutmeg show that:

If you invested the maximum amount you could put into a stocks and shares ISA on the first day of each tax year, from when they were launched in April 1999, and split the money between a corporate bond fund (a fund that basically lends money to different large companies in return for interest and an IOU) – the money should grow every year.

– You can rebalance your investments every year. If you split the amount of each fund you bought every year so that the overall investment ‘pot’ was always split 50:50 between the shares fund and the bonds fund, you would be rebalancing your investments.

SAVVY TIP: The reason you would be rebalancing is that you wouldn’t necessarily split your money 50:50 at the time you bought your investments. If, for example, the shares fund had performed really well over the last year its value would make up more than 50% of your overall investment portfolio. So that year you would buy fewer units in the share based fund and more of corporate bond fund.

– If you did this every year, after 14 years (up until 2012) the investments would be worth roughly £166,200 and you would have paid in approximately £102,880 in contributions.

– If you didn’t rebalance: If you didn’t rebalance your investments but just split your money equally between the shares fund and the company bonds fund, you would have approximately £162,900 over the same time period. That’s a difference of around £3,200.

Keeping costs low
What you invest your money in is important, but so are the charges you pay. When you invest money in a fund (as opposed to buying shares directly in an individual company, such as Marks and Spencer or BP) you are likely to pay someone to decide which shares to buy and sell and when to do so (called a fund manager).

1. The lower the charges levied by the fund manager, the more of your money is left to be invested

2. Passive funds, otherwise known as tracker funds, aim to replicate the performance of a stock market index or group of indices. The company running the fund – in simple terms – buys shares in the companies that make up the chosen index (or as close a match as is possible).

SAVVY TIP: The charges on passive funds tend to be much lower than on so-called ‘active’ funds.

3. A typical charge on a passive fund is low. It’s usually between 0.1% of the amount you’ve invested and 0.3% of the amount invested, every year.

4. Active funds are those where a fund manager, or team of fund managers, decides where to invest your money.

5. The typical charge on an active fund would be between 0.7% and 1.5% a year. There may be other charges as well.

Using your tax allowances
Another way to effectively make your money go further is to try and minimise the tax you pay on the proceeds. ISAs (individual savings accounts) are a good way of doing this.

– There are two types of ISA: cash ISAs (essentially a tax-free savings account) and stocks and shares ISAs – which are tax efficient investments.

– A stocks and shares ISA is a flexible, tax-efficient way to supplement your savings. There is no further tax to pay on dividends you receive from companies you’ve invested in via an ISA and no capital gains tax to pay.

SAVVY TIP: There’s a short video that explains how dividends work: VIDEO: Dividends from shares explained.

– You can invest a set amount in an ISA every tax year. The limit tends to rise every year and your new allowance ‘kicks in’ on April 6th.

– You can take money out of your stocks and shares ISA at any time.

Photo credit: Morguefile/Mconnors

Related articles:

Stocks and shares ISAs – ten tips from the experts

What is a stock market or stock exchange and how can you invest?

How to find an independent financial adviser you can trust

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