Balancing Act

Balancing Act

April 27, 2023

Portfolio Balancing Act

Balancing Act

April 27, 2023

Rebalancing is key to achieving your financial goals.

We just completed our proactive, semi-annual check of client accounts for rebalancing opportunities. Like much in life, rebalancing is hard precisely when it’s most important, and easier when it doesn’t matter as much. Rebalancing requires you to create a plan which sets out how much risk you are willing to take and to follow that plan. Rebalancing means ignoring your emotions, your friends’ advice, and the news cycle because it almost always means doing the opposite of what the rest of the world is doing.

Here's why.

Imagine you have a $3 mm portfolio and determined that you should own 2/3 stock and 1/3 bonds: $2 mm and $1 mm, respectively. You selected that mix based on your age, financial resources, goals and innate ability to stomach the stock market’s ups and downs without panicking.

Let’s assume that, over one year, the stock market declines by 25%, bonds are unchanged, and you have done no buying or selling. Your portfolio is now $1.5 mm stock and $1 mm bonds – down from 2/3 stock to 60% stock.

What should you do? The answer: sell enough bonds and buy that amount of stock to move you back to your 2/3 stock target. (In this example, the rebalance amount is $167,000.)

The reason: because the stock market declined, you have less opportunity for growth with only 60% in the market. Eventually, stocks will rebound. They always do. But you won’t get your fair share of that rebound if you do not rebalance, making it harder to achieve your financial goals.

The math isn’t complicated. But buying stock after the market has fallen is hard. Inevitably, the press and your close friends have nothing good to say about stocks. If you buy, you’re a lone wolf. That can feel dangerous.

The opposite situation is similarly challenging but for different reasons. After the market has risen significantly, you should sell stock and buy bonds. But that means selling when it seems stocks always go up. You feel like you’re missing out on free money. Worse still, when you sell, you will owe tax on the gain if you sell in a taxable account.

But you should sell. Here, I’ll use a real-life story. In the decade from 1990-2000, a 50/50 stock/bond portfolio grew into an 80% stock mix, with a dramatic rise in stocks, especially so-called dot com stocks. Most investors had too much risk. When tech stocks fell 25% in one week in April 2000, many investors gave up on investing. That meant they missed the rebound, making it harder to achieve their goals.

One final complication to prepare for: the stock market often builds momentum due to investor emotions. That means it can keep an upward or downward trajectory longer than expected. When you rebalance, you may feel you made a mistake because the market did not turn. But history tells us the market does not go in a straight line. You just need patience. Almost certainly, you will be glad you rebalanced.

Rebalancing is straightforward conceptually. But when emotions come into play, it can be hard. The solution:

  • Make a plan. Write it down. Share it with someone you trust who will hold you accountable.
  • Follow your plan, and don’t change course unless something fundamental changes in your financial life.
  • Or, hire a financial advisor and hold them accountable.

Like anything worth doing, rebalancing is hard, and it may take years for you to see the results. But it will pay off.

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This article is not intended to provide tax, legal, accounting, financial, or professional advice. Readers should seek advice from qualified professionals who can review their specific circumstances. Old Peak Finance endeavors to provide information that is accurate and current. However, we cannot guarantee that this information has not been outdated or otherwise rendered incorrect by new research, legislation, or other changes. Old Peak Finance has no liability or responsibility to any individual or entity with respect to losses or damages caused or alleged to be caused, directly or indirectly, by the information contained on this website.

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