The fallout of Russia’s invasion of Ukraine is being felt particularly hard in the eurozone, where the resulting price hikes in goods and services is expected to push inflation up to 8.6% in June 2022, Eurostat reveals.
The European Central Bank (ECB) has also indicated that it will increase its interest rates by 0.25% in July with a possible further increase in September to deal with rising inflation. This will be the first rate rise in the Eurozone in more than a decade, albeit from a very low base and with interest rates still in negative territory.
Small surprise that the combination of lingering covid impacts, inflation, interest rate rises and persistent supply issues on top of the Russian invasion of Ukraine, have created stock market uncertainty. Britain’s FTSE 100 and the EU’s Euro Stoxx were both volatile in June 2022, and America’s Wall Street officially entered a bear market after the S&P 500 dropped more than 20% from its previous peak.
While this stock market volatility is probably short term, and in the longer-term may create good investment opportunities, you might be wondering what steps you can take to ensure that your investments remain well placed to weather the storm and position for the next phase of market growth.
One thing you might want to consider is rebalancing your portfolio, which means realigning the weightings of your investments to where they were originally.
Read on to discover three reasons why you may want to consider this.
1. It makes sure your money is exposed to the right risk level
Investments usually consist of stocks, fixed income assets such as bonds, cash, real estate, commodities and some alternative assets, all of which can increase or decrease in value over time. When the stock market is performing well, higher-risk growth assets such as equities typically outperform defensive fixed income assets, meaning your investment’s exposure to stocks could increase.
As a result, the amount of risk your money is exposed to may become higher than you originally intended.
This is demonstrated in an example provided by Motley Fool, which shows how your investment risk could change if the value of your stocks and shares increases.
It provides the scenario of a €100,000 portfolio consisting of 70% equities and 30% bonds. This means that, at your original risk profile, you were happy to have a 70% exposure to higher-risk assets.
If the value of your equities increases over time from €70,000 to €105,000, and the bonds rise from €30,000 to €35,000, you would then have a 75% exposure to higher-risk assets. In other words, your money is exposed to greater risk.
When the stock market takes a downturn, as has happened in the first half of 2022, the inverse happens as your growth assets suffer a greater drop in value. In this case, your portfolio may become more conservative and perhaps limit your recovery opportunities.
By rebalancing your investment back to its original weighting, the level of risk is reduced back to the level you originally intended it to be.
2. It ensures your investments are diversified
Diversification is one of the most effective ways to manage investment risk and increase growth potential. This is because your money is typically spread across a range of asset classes, and investments that are in different countries,, sectors, currencies and industries.
As these different investments react differently to global or economic events, it can reduce the overall risk that your investment portfolio is exposed to. As such, if the market falls, your investments are less likely to suffer the sharp losses you could experience if you put all your money into a single market or asset type.
To illustrate this, consider how the stock market performed in 2020 after the Covid pandemic gripped the world.
According to Bloomberg data, published by the BBC, between the outbreak in March 2020 and January 2021, the UK stock market, the FTSE 100, dropped 11.6%, while China’s Shanghai index increased by 16.1%.
If you had invested in just the FTSE 100, your investments would have seen a significant drop in value. By including exposure to the Chinese market in your portfolio as well, as a simple example, your net performance across that time period would have been considerably better.
As part of rebalancing is assessing your portfolio’s diversity, it could help reduce risk and may even expose your money to greater long-term growth potential.
3. It makes the most of the stock market’s changing cycles
As markets are cyclical in nature, different asset types such as shares and government bonds increase and decrease in popularity and performance. This is reflected in investment focuses, for example with high yield dividend paying shares typically more popular in volatile markets.
In a robust market, share selection may be biased towards future earnings potential with growth stocks being more sought after. At this level, rebalancing is not just moving between asset classes but adapting focus within asset classes.
This is where a good financial and investment adviser will work with you to manage your portfolio across the cycles to optimise performance and minimise volatility.
Get in touch
While rebalancing is something you may need to consider, always speak to a financial planner to confirm whether it’s the right thing for you, and to understand any costs that might arise.
As specialists in helping expats in Europe, we ensure that your investments are well diversified and appropriate for your specific circumstance. If you would like to discuss how we may be able to assist you, email us at [email protected] and we’d be happy to discuss your situation further.
This article is for information only. Please do not take action that is based on anything you read in this article until you have sought professional advice.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.