Source: ETF Securities.
A word of caution: when mixing combinations of ETFs, active funds and individual securities, investors should be careful how they are affecting their overall asset allocation and exposure to risk factors such as currencies, sectors or individual securities. This should involve a thorough examination of the underlying assets held in each ETF or managed fund to ensure there are no unintended over-weighting to particular areas.
Rebalancing and review
Equally important to setting an asset allocation strategy is deciding how to keep your portfolio aligned with your goals over time. This involves both reviewing your asset allocation periodically and adjusting, or rebalancing your asset selection to ensure they remain aligned.
For many SMSF investors, particularly those with long horizons, asset allocations should be reviewed, but it is unlikely that adjustment will be necessary unless there have been major changes to an individual’s circumstances. For many, a periodic review every three to five years is sufficient. Investors closer to retirement should more actively monitor their allocations.
Portfolio rebalancing is equally important and is something that many self-directed investors neglect. Over time, your portfolio holdings will probably drift away from their target levels. This happens naturally as the value of assets goes up and down relative to each other and as income is distributed.
A prescribed and disciplined approach to rebalancing is the key. Too infrequent rebalancing can result in sub-optimal asset allocations, while too frequent rebalancing can result in unnecessary trading and high transaction costs. This is especially true for investors managing small portfolios.
There are two main ways to approach portfolio rebalancing. The first monitors the allocations on a regular basis and rebalances as soon as they move away from target by a predetermined amount, say, 5 per cent or 10 per cent. The second approach, which involves less oversight, simply rebalances with a predetermined frequency. It is generally recommended to rebalance on at least an annual basis.
Summary
ETFs provide SMSF investors with a wide range of portfolio diversification options and the investment choices available will increase over the coming years.
While there are many approaches to building a portfolio of ETFs, investors should always keep three key questions in mind:
- does their portfolio fit with their overall objectives;
- do the individual assets in the portfolio complement each other and are their underlying exposures understood; and
- is it clear on what basis the portfolio will be reviewed and rebalanced?