Markets are going up, stocks at some record highs, portfolio performance above target, this may sound familiar to you at this moment in time and quite possibly since April 2020.
With all this positivity, should we not think about how we protect ourselves against the downside risk? What should you be doing if these rises are causing your portfolio to move out of line with your original risk profile?
Benefits Of Rebalancing
When creating the original portfolio, you will have gone through an asset allocation process, and this will align your thoughts and plans for growth and make sure that the structure is correct at the outset.
If you then discussed parameters of risk and the positive and negative movements you are prepared to take before making changes, this too would have assisted in keeping the portfolio in line with your Goals.
Each person will have a different tolerance to risk, which will affect how the asset allocates to their plan.
When the Investment is made, the risk profile is correct; over time, this will change as the performance of the portfolio changes, with constant fluctuations, both positive and negative. It could mean your portfolio moves out of line with your intended plans. This is where rebalancing will play its role in bringing back into line the asset allocation, along with the target percentages established at the outset.
When To Rebalance Your Portfolio
A key point to emphasize is that you should consider rebalancing at reasonable intervals. Typically, this is done quarterly, semi-annually or even annually, dependent on the investment firms process.
Exceptions to this would be after a significant market move up or down. Another exception would be having a considerable amount to invest in a lump sum. In this case, it makes sense to direct that money towards underweighted holdings to rebalance as needed.
Portfolio rebalancing is often accomplished by selling holdings in asset classes where the portfolio is overallocated. Then you redirect those funds to positions in underweighted asset classes. In doing this, it’s essential to take a total portfolio view.
As trades are processed to rebalance your portfolio, transaction fees and/or commissions may be involved. Depending upon your custodian’s platform, some of these might function as normal trading costs for ETFs, stocks, or some mutual funds.
If you work with an advisor whose compensation is derived all or in part from the commission paid to them, this type of situation should raise some questions in your mind.
While sometimes it is impossible to avoid transaction fees, we recommend that you know what the fees are and that it may be best to work with a fee-based approach where you know at the outset what your adviser will charge.
Sticking To A Rules-Based Approach
Money is an inherently emotional topic. These emotions can be further exacerbated by the fact it is impossible to time the market consistently.
It can fuel regret at missing that hot stock or new opportunity and might cause you to jump in after a security has experienced a sizable gain. Fear Of Missing Out (FOMO) can be a powerful and potentially damaging emotional response.
It’s essential to keep your focus on track with your long-term investment plan and in line with your original goal. It is best practice to rebalance your portfolio based on predetermined rules.
It might be every six months, annually, or when your stock/bond allocation falls by a particular percentage outside of your original targets due to a significant market event. In the end, a rules-based approach takes the emotion out of managing your investments.
Here at Corestone, we use a formula that considers all the above points, so if you need help with rebalancing your portfolio, why not get in contact.