View from the Chair: Windermere’s Market Perspectives (December 2019)

December 6, 2019

Rebalancing. One of many investing buzzwords that deserves a closer look.


Let’s start with your target allocation. When you started investing, a target allocation was set for you and your specific situation, based upon a variety of factors including risk tolerance, liquidity needs, timeline, long-term goals, and many others. Your target allocation specified how much of your total investment portfolio should be placed in various buckets (such as cash, bonds, stocks, foreign stocks, and perhaps alternative investments like real estate properties or investments in private businesses).

Over time, as your investing journey continued, the values of the investments in your various buckets went up and down. At any given time, you can calculate the total in each bucket as well as the percentage it represents of the total. This is called your actual allocation.

Rebalancing is the process of comparing your target allocation to your actual allocation and making necessary adjustments. It is an important practice that requires considerable discipline, both in good times and bad.

Let’s start with good times – a time period when all asset classes do relatively well. Inevitably, even when everything is rising in value, one category will outpace another. As a result, you may find yourself with a bucket that has an actual allocation outside of target. Rebalancing would suggest you sell from that bucket and add to those that have fallen below target. In short, you’re selling high and buying low(er)

This becomes considerably harder in bad times – a time period when asset class(es) fall far and fast. December 2018 is a perfect example. During that month, stocks fell very quickly and experienced double digit declines. These moves resulted in many equity allocations being below target. Rebalancing at this time would have required selling buckets such as cash or bonds and adding to equities (even as their prices fell). This is not an easy task.

This is a simplified explanation of rebalancing. But of course, it’s never that easy. Here are a few things to keep in mind:

1.) Conscious decision – You may make a decision to remain over or under target in an asset class. This could be for a variety of reasons (such as liquidity needs, outlook for certain asset classes in near term, etc). This is a very reasonable approach (and one we often deploy). The key word is conscious. You need to continually monitor the relationship between target and actual and ensure that you know why you are out of sync

2.) Targets are there for a reason – We set target allocations for a reason. They help us as investors to reach our long term goals, based upon our best understanding of expected future returns. Considerable time and effort is put into setting your target allocation at the outset. Deviation from that target for prolonged periods of time may impact the ability to reach your long term goals

3.) Targets keep us from reacting – Target allocations are always important, but we would argue they are exceptionally important during market corrections. It can be very easy to react when our investment balances fall and without a target allocation or long term plan, we may be tempted to move to safety (ie: cash). But with a disciplined approach surrounding rebalancing, our rationale thinking may outpace emotion – even in bad market times

4.) Targets can change – as your life circumstances change, your target allocation may need to change as well. Perhaps you are moving from an accumulation/savings stage to a distribution stage. Perhaps you want to lower your risk profile. Perhaps you need more income. Whatever the reason, it can be assessed and factored into your target allocation.

Rebalancing is an essential discipline for every investor. Take the time to look at your buckets and see if any changes are prudent. Your long-term goals will thank you!

Invest on,

Pam

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