Portfolio Rebalancing: The Dull Discipline

by | Nov 11, 2021 | Advice that Matters, Investment Discipline

The famed economist John Maynard Keynes once quipped:

“The market can remain irrational longer than you can remain solvent.”

Or employed. Or happily married.

It’s easy to get complacent when we watch our account balance increase during the great melt up over the past 11-12 years. The record fast market decline from COVID was offset by an equally fast recuperation that was driven by large doses of fiscal and monetary stimulation. Some analysts believe innovation and millennial money will drive a bull market that lasts decades. Maybe. History says otherwise. Do you want to risk all your retirement money against the historical odds?

How to have the best of both worlds. In a sense, that’s what rebalancing is about. You may give up some return in exchange for a little more stability. And you may be able to increase returns.

I call rebalancing the dull discipline because there is no flash or false promise of instant riches. It’s a sound investment principal. Investment is not to be confused with hype and speculation. Speculation may have a place in a portfolio but only with money you are prepared to lose. Whereas the primary function of rebalancing is to control your risk. Secondarily, it may also enhance returns. There is a wealth of academic literature on how, how often, and when to rebalance. However, square one for prudent investment decision making is to get the asset mix right for you.

The table shows stock ranges in an asset mix by wealth stage and age. Stocks generally decline as we age, but it can vary depending on one’s facts and circumstances (i.e. level of wealth, taxes, expenses, health, debt, gifting goals, risk tolerance, and risk capacity to name a few). Hence, the reason that the age ranges overlap. The right range is not a boilerplate or one-size fits all formula.

What is Rebalancing

In brief, rebalancing is selling things that have gone up the most and buying things that have went down the most. Not complicated. Easier said than done. Because who wants to sell their winners and buy their losers, right?

Why Rebalance

We established an asset mix for you when we began our relationship based on a risk survey and a discussion of various issues. Rebalancing moves us back to that initial mix as the portfolio shifts over time. This controls the variation or risk of movements in your portfolio.

How to Rebalance

We can rebalance by time intervals (i.e. monthly, quarterly, annually): research shows that rebalancing too often degrades returns due to transaction costs. And does nothing to enhance returns. Or we can also rebalance by threshold (e.g. if my 50-50 portfolio mix becomes 57-43, I should sell 7% equity to get back to my initial 50-50 mix). The threshold approach gives us more flexibility to take advantage of market movements, while keeping within your risk comfort zone.

Rebalancing Varies with Age and Your Goals

Growth Stage (22-50ish – savings & accumulation). Rebalancing is less important in this stage because we plan on you having a long time until retirement as well as many years in retirement. As you save, the money should be put into the assets that perform the worst and that help to keep your mix aggressive in the early years.

Preservation Stage (50-70ish – don’t lose what you’ve accumulated). Psychology and practical considerations come into play. Here it is important to maintain discipline. I’ve seen situations where people have been over aggressive, but then sold during declines because “it’s all I have for retirement. I can’t lose any more.” Only to watch the market eventually recuperate and miss the future growth. “Sell-low, buy-high” lacks discipline and creates poor outcomes.

Decumulation Stage (60ish-retirement – how to safely withdraw money without running out). We “sell high” those assets that go up the most and use it for your spending needs. o When stocks are up, sell to create spending money; if they are down, use bonds. You never want to be selling assets when they are down to fund spending if it can be avoided. This can permanently destroy value and could forever alter your path in retirement.

The discipline is dull but it’s easier said than done. Rebalancing has proven much more effective than trying to time the highs and lows in the market because it minimizes the emotions that come with market turmoil.

I hope this demystifies the jargon and clarifies rebalancing for you. If not, my contact info is below.

Jerry Matecun – Founder, President

Expert guidance to plan your future, preserve your lifestyle, and retire with confidence. For a confidential consult, contact me at jerry@compoundvalue.com.

PLEASE NOTE: Nothing herein constitutes investment, legal, or tax advice. For details please see Disclosure.

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