Value of rebalancing portfolio – a very good idea

 

Why Rebalance?

You probably know that your investment portfolio is being rebalanced on a regular basis, but you might not know why.  Is it for higher returns?  Do we rebalance in order to maintain the agreed-upon balance of investments that is in your risk tolerance comfort zone?  Does rebalancing help manage portfolio risk?  Also, rebalancing may seem counter productive given that the markets are performing a record levels.

The answer to the above is “yes,” “yes,” and “yes,” but with a qualification.  Rebalancing an investment portfolio is most importantly a form of discipline, a way to reduce the impact of those dangerous emotions of greed and panic on the investment process.

Rebalancing is necessary because all of the moving parts in your portfolio rise and fall at different times and degrees.  During a bull market, stock prices rise faster than bond values, causing them to make up a larger percentage of the portfolio than you signed on for.  Similarly, when the bear growls, stocks will fall faster than bonds, causing your portfolio to become more conservative.  Real estate investments and commodities often rise or fall at different times than stocks or bonds, pulling your overall percentage allocations away from the target mix.

So what does rebalancing accomplish?  When you rebalance, you’re selling the assets that rose in price and buying the ones that went down.  This discipline results, over time, in consistently buying when an asset goes on sale, and selling when the asset becomes more expensive.

There are three ways to rebalance.  The easiest is to use whatever new money is coming into the portfolio, monthly or quarterly, to buy the assets that have gone down, allowing you to make consistently fine adjustments that keeps the portfolio at its prescribed allocations.

Another possibility is to rebalance at certain times of the year—every three, six or 12 months.

Or you could follow the most complicated process, and rebalance whenever assets deviate by more than certain set percentages from the baseline asset allocation.

A recent article on the Seeking Alpha website notes that rebalancing reduces portfolio volatility, because you are not allowing the stock allocation to rise in the portfolio during bull markets (which would set you up for a bigger drop when the market rise turns into a bear market).

An illustration in the article, using a simple mix of 60% stocks and 40% bonds shows that rebalancing using the percentage deviation method would have led to higher overall returns from the beginning of 2000 to January 2016.  It found that wider bands produced higher returns (and fewer rebalances), although of course there is no guarantee that this would be the case in the future.

But perhaps most importantly, rebalancing gives you back, over and over again, the portfolio that you expected when you started, the portfolio whose expected long-term returns are incorporated in your financial plan, the portfolio you were most comfortable with when the investment process was first discussed.  And when it comes to making decisions in a time of crisis, having a rebalancing policy in place ensures that they will be made with discipline, rather than emotion.

Contributed by Bob Veres

Source:

https://seekingalpha.com/article/4075169-value-tactical-rebalancing?page=2

About Objectively Speaking

Tom Batterman, founder of Vigil Trust & Financial Advocacy and Financial Fiduciaries, LLC is in the business of representing the best financial interests of his clients. Having provided objective, fee-only financial management services for over two decades, he specializes in managing the investment and related financial affairs of individuals and mutual insurance companies who do not have the time, interest or expertise to manage such matters on their own. As an objective, unbiased professional who takes on a fiduciary responsibility to his clients, he guides clients to the financial decisions they would make themselves if they had years of training and experience and the time and expertise to fully research and understand all of their options. Founded in 2010 as an outgrowth of Vigil Trust & Financial Advocacy, Financial Fiduciaries, LLC is a financial management solution for individuals and mutual insurance companies who recognize they do not have the time, interest or expertise to properly attend to their financial matters on their own. While there are many financial “advisors”, most of them have investment products to sell and the “advice” they provide is geared toward getting their clients to engage in a purchase. As one of the rare subset of advisors known as “fiduciary advisors”, Financial Fiduciaries does not sell any investment product so its guidance is not compromised by conflicts of interest which plague ordinary advisors. Prior to his employment in the financial industry in financial advocacy and trust positions, he worked at a private law practice in the Wausau area in the areas of estate planning, tax, retirement planning, corporate organizations and real estate. He is a graduate of the University of Wisconsin-Madison and the UW-Madison Law School and has during his career held Series 7, 24 and 65 securities licenses. A longtime resident of the Wausau, Wisconsin Area, Tom is active in the community. He enjoys golf, curling, skiing, fishing, traveling and spending time with his family.
This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s