Rebalancing Your Portfolio
Determining the right mix of investments in a portfolio—the appropriate allocation to equities, fixed- income and other financial assets—is arguably the single most important decision an investor can make. What defines “right” is a uniquely personal matter that is a function of your goals, risk tolerance and time horizon.
Working with you to design a strategic allocation to prudently reach your financial destination is one of your Investment Counselor’s most vital tasks. This effort is supported by the resources of our Wealth Advisory Group, which models customized scenario analyses for a range of possible allocations.
Portfolio allocations will fluctuate over time. You may shift your target deliberately as your goals or time horizon change. The allocation will also drift on its own because individual asset classes tend to move in different directions. This is one of the benefits of diversification—and one of the challenges of asset allocation.
Experience and research have shown that bringing allocations back into balance by “selling high” those investments that have performed better and using the proceeds to “buy low” assets that may have lagged tends to smooth a portfolio’s path, giving it an enhanced risk-adjusted return.
Our portfolio control team regularly monitors every account’s stated allocations, trimming investments in asset classes that have exceeded target levels in order to increase exposure to those that have fallen behind. This process removes the decision-making distortions that emotional reactions can cause.
For instance, when an asset class is down, that is generally the most opportune time to buy. However, our emotions and behavioral biases may instead cause us to favor what has gone up. That’s because we have a tendency to over-emphasize recent events and get very emotional about even small losses.
Rebalancing, though painful at times, automatically keeps you on track and often has the greatest impact when it feels the most uncomfortable.
Risk and reward reconsidered
Dramatic shifts in the markets during 2008 amplified the importance and challenges of rebalancing. Volatility in virtually every asset class rose to levels unseen in eight decades. In light of this, you may want to review the assumptions on which your initial allocations were built—not just the balance among your investments, but also your long-term return goals and risk tolerance—to see whether anything has changed.
Dialing down risk and reconsidering your true aspirations may be appropriate if you have a short time horizon or now realize that your appetite for market volatility is less than you initially anticipated. However, it’s important to avoid the temptation of acting based on recent history or emotions alone.
Keep in mind that markets always move in cycles. Just as prices for risky assets have collapsed, risk-free securities have arguably grown too expensive. Excessive caution now offers minimal rewards.
Short-term Treasuries, for instance, effectively pay no interest. At the same time, corporate bonds sell near Depression-era prices. Stocks also reflect acute, perhaps excessive, stress, with price/earnings ratios at multiyear lows.
Indiscriminate bear markets often set the stage for future rallies. They knock down the prices of outstanding companies with solid revenues, secure balance sheets and strong prospects. Such fundamentally sound companies are poised to advance when the subsequent recovery takes hold.
Revisiting your allocation
Given the uncertainty in today’s markets, this is an opportune time to review the allocation you originally set with your Investment Counselor. You should discuss whether a course correction or more fundamental change in strategy is appropriate, including altering the pace of rebalancing your portfolio.
We recommend that you start this review from the perspective of determining what kind of return you need from your portfolio to meet your goals. With improved prospects for both equities and fixed-income securities going forward, you might even be able to achieve your desired rate of return with a lower exposure to riskier asset classes.
As always, if you have any questions about our rebalancing process, don’t hesitate to contact your Investment Counselor.