Rewarding experiences often occur just once a year – no more, no less.
These include, to name a few:
- July 4th fireworks
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
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 mis-informed) 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 multiasset
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
- 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 TBenner@CNBank.com.
*Analysis: Canandaigua National Bank & Trust; Hypothetical example based on lump
sum returns of an account starting at $100,000, weighted evenly among the S&P 500,
Russell 2000, Russell 2000 Value, U.S. REITs, MSCI EAFE, World ex-U.S. Value, and U.S.
Gov’t/Credit Intermediate Bonds.
This material is provided for general information purposes only and is not a recommendation or solicitation to buy or sell any particular security, product or service. Past performance is not indicative of future investment results. Any investment involves potential risk, including potential loss of capital. Before making any investment decision, please consult your legal, tax and financial advisors. Non-deposit investment products are not bank deposits and are not insured or guaranteed by Canandaigua National Bank & Trust, or any federal or state government or agency and are subject to investment risks, including possible loss of principal amount invested.
Tax information presented is not to be considered as tax advice and cannot be used for the purpose of avoiding tax penalties. Canandaigua National Bank & Trust does not provide tax, legal, or accounting advice. Please consult your personal tax advisor, attorney, or accountant for advice on these matters.