Rewarding experiences often occur just once a year – no more, no less.These include, to name a few:
- Birthdays
- July 4th fireworks
- Rebalancing
Let’s skip to number 3 because mostpeople are likely unaware of the benefits from thissimple yet lucrative aspect of successful investing.
What is rebalancing?
To begin, determine your long-term financial goals and develop aglobally diversified asset class portfolio that supports reaching them.For example, if your investments must grow significantly in orderto comfortably sustain annual withdrawals throughout retirement,sufficient exposure to stocks may need to be maintained.
Once the proper asset allocation has been established for yourportfolio, each year some market segments will do better thanothers which will cause the original allocation to get out of whack.Rebalancing the portfolio merely gets it back aligned. This willinvolve selling funds (if you now own a higher percentage of thetotal than targeted) or buying funds (if it’s now lower). That’s it. Manyinvestors find January to be a good month to establish disciplinedannual rebalancing since they will know their portfolio is allocatedas intended at the start of every New Year.
Won’t that require selling some of my recent winners andbuying underperformers?
Absolutely, which is the whole point -- regularly selling high andbuying low. What drives profits for businesses applies equally to yourinvestments. That’s why it is also important to avoid costly funds aswell as taxes generated by frequent trading since every dollar spenton costs and taxes is a dollar less earned from the investments. Toillustrate, suppose your asset allocation is currently 60% stocks and40% bonds. Then, after a good year for equities, the allocation driftshigher to 70% stocks and 30% bonds. Rebalancing would entailselling some of the stock exposure and using the proceeds to buybonds, with the goal being to get back to the strategic 60/40 allocation.
What are the benefits?
Essentially, disciplined portfolio rebalancing takes the emotion out ofmarket timing decisions (that are often misinformed) in exchangefor a more proven behavior. The portfolio will not wander off fromintended allocations which helps contain risk exposure and alsoleads to more reliable results. Regularly selling securities for gainscontributes to a positive investment return while providing proceedsto buy more of funds that are relatively cheaper, thereby contributingto additional future gains. Plus, the portfolio is kept at a risk level theinvestor is likely more comfortable with.
As a bonus, you’ll usually end upwith more money over the longrun which increases the rewardfor saving and investing. Studieswe conducted for rolling 20-yearperiods since 1979 with a multi assetclass portfolio showed that annual rebalancing led to a higher ending total andlower risk/volatility about 80% of the time comparedto equivalent portfolios left unattended. The averageincrease was more than 1/3 of the original balance.
In other words, on average, regularly rebalancing a starting $500,000portfolio grew the eventual balance after 20 years an additional$150,000 vs. one not rebalanced.*
Step by step recap:
- First: Develop a financial plan and investment asset allocationthat will reliably achieve your long-term goals.
- Second: Stick with the strategy despite periodic market volatilitywhich is unavoidable and unpredictable.
- Third: Utilize low cost, tax efficient funds to keep more money inyour pocket.
- Fourth: Rebalance annually.
Is this strategy easy to manage and commonly done?
In a word, no. Developing an intelligently diversified, low-costinvestment portfolio that will reliably achieve your long-term financialgoals can be quite a task. Furthermore, not only is remembering torebalance the same time each year challenging, actually sellingfunds that have been your best winners and then using the gainsto buy recent losers is understandably more than most folks canstomach. After all, when stocks plummeted 50% during the recent2008 financial crisis, were you eager to load up and buy more?That’s what the appropriate professional investment manager will do,however. Each year, rain or shine, the portfolio will be rebalancedback to its strategic allocation in order to maximize the probabilityof reaching your cherished long-term goals.
*Analysis: Canandaigua National Bank & Trust; Hypothetical example based on lumpsum returns of an account starting at $100,000, weighted evenly among the S&P 500,Russell 2000, Russell 2000 Value, U.S. REITs, MSCI EAFE, World ex-U.S. Value, and U.S.Gov’t/Credit Intermediate Bonds.
This material is provided for general information purposes only. Investments and insurance products are not FDIC insured, not bank deposits, not obligations of, or guaranteed by Canandaigua National Bank & Trust or any of its affiliates. Investments are subject to investment risks, including possible loss of principal amount invested. Past performance is not indicative of future investment results. Before making any investment decision, please consult your legal, tax or financial advisor. Investments and services may be offered through affiliate companies. Tax information presented is not to be considered as tax advice and cannot be used for the purpose of avoiding tax penalties. Canandaigua National Bank & Trust does not provide tax, legal, or accounting advice. Please consult your personal tax advisor, attorney, or accountant for advice on these matters.
