As we come to the end of a tumultuous quarter, we are now approaching the time when we rebalance our client portfolios to our targeted asset classes. In less volatile markets, rebalancing appears routine and uneventful, however, in times of large market swings (both positive and negative), rebalancing can seem risky or unnecessary. Below, we try and shed some clarity on the importance of rebalancing portfolios. What is Rebalancing? First, it makes sense to start by defining rebalancing. All of our clients' portfolios contain diversified asset classes (stocks/bonds/cash), with more risky portfolios having a greater allocation to stocks. As stock and bond markets move up and down, our initial targeted allocations for stocks/bonds/cash move out of alignment. Rebalancing is the process of selling and buying investment positions to realign the portfolio to our targeted allocation and risk level. It is important to remember that asset allocation has been shown to explain over 90% of portfolio results (Brinson, Beebower, Hood; 1986). Why Do We Rebalance? Routine portfolio rebalancing has several distinct advantages helping long-term investors become successful. Below are the key features we value:
Manage Portfolio Risk - With routine portfolio rebalancing, we maintain our portfolio's targeted risk level. This is important because financial plan success is based on a defined portfolio risk level to meet long-term goals. When the portfolio becomes riskier, it increases the chance of unexpected volatility hurting plan probabilities. When the portfolio becomes less risky, it increases the risk of not being able to meet the long-term financial plan goals.
Manage Emotions - Investing is an emotional process. It is difficult watching portfolio values move up and down with market movements. By creating a quarterly rebalancing routine and pairing that with a comprehensive financial plan, some of the emotion can be removed from investing. A disciplined rebalancing strategy is also expected to improve the risk-adjusted return of a portfolio over time.
Optimizes Taxes - Rebalancing provides an opportunity to optimize a portfolio based on taxes. It may make sense to realize gains or losses to take advantage of the current tax rules.
What is BPC Advisors Rebalancing Methodology? Having a process for rebalancing creates the discipline for monitoring portfolios' risk tolerances. At BPC Advisors, we review all accounts on a quarterly basis and target rebalancing when stocks or bonds are out of alignment by ~ 2%. What Do Others Say? It is important to look at other independent research when it comes to rebalancing as well. Vanguard published a study called "A Smart Guide to Rebalancing" as part of their Financial Planning Perspectives series. If you would like a deeper look into the importance of rebalancing, this is a great article. Summary We strongly believe that portfolio rebalancing serves an important role in long-term investing and financial planning. As there may be questions on the rebalancing process, we wanted to share our guidelines prior to rebalancing client portfolios. We expect this process to occur in the coming days. Please let us know if you have any questions about your personal portfolio.
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