The Importance of Rebalancing

The Importance of Rebalancing Your Portfolio

The financial planning process is an in-depth look  into a client’s financial health. Before a financial plan can be crafted, there are many hours of discussion between an advisor and their client. A financial advisor will spend many hours sifting through financial documents in order to gain an understanding of what resources a client has and how best to utilize them. From there, it can take ten to twenty hours to create a plan based on the individual needs of each client. Once the plan has been devised, an advisor and their client will work together to implement the plan.

If you’re working with a fee-only financial advisor (as you should be), that can be the end of the business arrangement. The initial financial plan should lay out a roadmap going forward for years to come. There is no value in paying for a plan year after year, though you should review and update the plan after any major life event. The life events include marriage, the birth of a child, a change in jobs and the like.  

Most folks will hire an advisor to manage investment assets as well. The reason that most people opt for professional financial management is that monitoring your investments is a vital part of any financial strategy. While you have to pay for this service, which is usually a percentage of assets under management, the return on investment is usually worth the extra expense.

The reason why this service is of value is that a good financial advisor helps take the emotion out of investing. After the market crash in 2008, many people went against the advice of financial professionals and sold all of their investments. They sold at the bottom. Many waited until the market rebounded to move back into the markets. They basically waited until the sale was over.

One of the best examples of the value of working with an advisor came from the tech bubble burst.  Many people chose to jump into the exciting bull market of the late 1990s. Even if you had a balanced portfolio prior to the market bubble, the growth of technology stocks caused many investment portfolios to become heavily weighted in tech. When the bubble burst, it was bad enough for the folks who actively sought out tech company investments. For the unintentional victims, those that had simply not been paying attention to their accounts, the pain was mixed with confusion. 

Financial advisors, against the popular emotions of the time, would not have recommended investing in the latest fad. As the technology stocks gained value, an advisor managing the portfolio would sell off the gains made in that sector and invest the funds in poorly performing areas of the economy. This is the simple concept of buying high and selling low. Everyone seems to know that this is the key to investing, yet few follow that key advice.

For my client’s, I start by gaining and understanding the timeframe they are looking to invest as well as how comfortable they are with the market losses.  Once I understand this I invest appropriately. From there, I rebalance the portfolio’s quarterly. The core of my investment strategy is a well diversified portfolio because history has proven time and time again that no one can predict the future.  There are no tea leaves to read. There are no tools or charts that can guarantee investment growth. The only thing that works is admitting you cannot predict the future and to plan accordingly.  

I like to use the analogy of the Ferris wheel to help my clients understand my process. The tech bubble was a bit like putting all your money in one bucket on the Ferris wheel. When a wind happened to blow that bucket over, all of the money fell out. Instead of putting all my clients funds into one bucket, I spread the wealth around. When the money is in the top bucket, I know that eventually it will start heading down. I take the money from the top and move it to the bottom bucket, because I know that bucket has nowhere to go but up.

Sure, there are times that I’ll react to market conditions or recommend favorable investments as they come up, but the majority of the time, I want to focus on a core strategy. Does this strategy work? Yes.  In fact, it’s been proven repeatedly over time to be one of the few strategies that consistently works.  

Looking at the cart below, you can see the difference in values between a portfolio that is rebalanced and one that has not been.

Right now, we’re in the second longest bull run the stock market has seen. I know that what comes up has to come down eventually. The economists working for the State of Arizona predict a market downturn in 2018. Day to day, the noise from the markets cause investors to buy and sell based on emotion (as I write this Janet Yellen is talking about interest rates, which has caused the DJIA to plummet). My role as an advisor is to ignore it all and place the interests of my clients first.  

The chart below shows the returns from an actual client of mine.  This is a moderate allocation with a long time horizon. Even during the turbulent market swings of 2016, the portfolio has outpaced the S&P 500 we benchmarked. The illustration points out the benefit of portfolio rebalancing. While the investments have made a respectable 4.09% rate of return, my clients personal rate of return is 9.16%.  

The personal rate of return is nearly 6% higher than the much more volatile S&P 500 market index. 
Mind you, this is a short term snapshot of a long term investment strategy, but the results are impressive. The higher rate of return is explained by the fact that I took the emotion out of investing.  We simply took the winners that quarter and sold them. With the available cash, we bought the losers.  Is this an extremely easy strategy to employ? Yes, and I would encourage every investor to do so.

It’s emotion that prevents most folks using such a simple strategy. People have a hard time letting go of a winner. It’s common to confuse a high stock price or historic fund performance for an indicator for future success. Many years ago, a client I was working with at Merrill Lynch balked at the idea of paying to work with a financial advisor.  He was a smart and successful engineer, but it didn’t look like he would ever reach his retirement goals. I looked over his many 401k plans that he had built up over his career and pointed out his low returns. I had to ask, if you’re not working with an advisor, how are you coming up with your investment strategies? 

His answer? He simply moved all of his investments every year into the fund that had the best previous one year return. He bought at the top of the Ferris wheel and rode it down every year for 12 years straight. His rate of return was just over 1%. He still didn’t see the value of paying an investment professional to help, even when presented with hard numbers. What he failed to realize was that an advisor is far more than a stock broker. An advisor is there to be an impartial guide for your future.

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