Rewarding experiences often occur just once a year – no more, no less. These include, to name a few:

• Birthdays
• July 4th fireworks
• Rebalancing

Let’s skip to number 3 because most people are likely unaware of the benefits from this simple yet lucrative aspect of successful investing.

What is rebalancing?

To begin, determine your long-term financial goals and develop a globally diversified asset class portfolio that supports reaching them. For example, if your investments must grow significantly in order to comfortably sustain annual withdrawals throughout retirement, sufficient exposure to stocks may need to be maintained.

Once the proper asset allocation has been established for your portfolio, each year some market segments will do better than others which will cause the original allocation to get out of whack. Rebalancing the portfolio merely gets it back aligned. This will involve selling funds (if you now own a higher percentage of the total than targeted) or buying funds (if it’s now lower). That’s it. Many investors find January to be a good month to establish disciplined annual rebalancing since they will know their portfolio is allocated as intended at the start of every New Year.

Won’t that require selling some of my recent winners and buying underperformers?

Absolutely, which is the whole point -- regularly selling high and buying low. What drives profits for businesses applies equally to your investments. That’s why it is also important to avoid costly funds as well as taxes generated by frequent trading since every dollar spent on costs and taxes is a dollar less earned from the investments. To illustrate, suppose your asset allocation is currently 60% stocks and 40% bonds. Then, after a good year for equities, the allocation drifts higher to 70% stocks and 30% bonds. Rebalancing would entail selling some of the stock exposure and using the proceeds to buy bonds, with the goal being to get back to the strategic 60/40 allocation.

What are the benefits?

Essentially, disciplined portfolio rebalancing takes the emotion out of market timing decisions (that are often misinformed) in exchange for a more proven behavior. The portfolio will not wander off from intended allocations which helps contain risk exposure and also leads to more reliable results. Regularly selling securities for gains contributes to a positive investment return while providing proceeds to buy more of funds that are relatively cheaper, thereby contributing to additional future gains. Plus, the portfolio is kept at a risk level the investor is likely more comfortable with.

As a bonus, you’ll usually end up with more money over the long run which increases the reward for saving and investing. Studies we conducted for rolling 20-year periods since 1979 with a multi asset class portfolio showed that annual rebalancing led to a higher ending total and lower risk/volatility about 80% of the time compared to equivalent portfolios left unattended. The average increase was more than 1/3 of the original balance.

In other words, on average, regularly rebalancing a starting $500,000 portfolio grew the eventual balance after 20 years an additional $150,000 vs. one not rebalanced.*

Step by step recap:

• First: Develop a financial plan and investment asset allocation that will reliably achieve your long-term goals.
• Second: Stick with the strategy despite periodic market volatility which is unavoidable and unpredictable.
• Third: Utilize low cost, tax efficient funds to keep more money in your pocket.
• Fourth: Rebalance annually.

Is this strategy easy to manage and commonly done?

In a word, no. Developing an intelligently diversified, low-cost investment portfolio that will reliably achieve your long-term financial goals can be quite a task. Furthermore, not only is remembering to rebalance the same time each year challenging, actually selling funds that have been your best winners and then using the gains to buy recent losers is understandably more than most folks can stomach. After all, when stocks plummeted 50% during the recent 2008 financial crisis, were you eager to load up and buy more? That’s what the appropriate professional investment manager will do, however. Each year, rain or shine, the portfolio will be rebalanced back to its strategic allocation in order to maximize the probability of reaching your cherished long-term goals.

How CNB Can Help

Please feel free to contact us with any questions you have. Thomas Benner can be reached at (585) 419-0670 ext: 50689 or via email at [email protected].