Rebalancing Trade Alert
With this update, I’m giving you trades for rebalancing the Aggressive portfolio (100% equity) and the Moderate portfolio (60% equity/40% fixed income).
Any time the broad market declines 10% or more, into correction territory, it’s wise to evaluate your holdings and be sure nothing has strayed too far out of line from your predetermined allocation.
New Portfolio Allocations
| 60/40 Model | Old Allocation | Adjustment | New % Allocation |
| COMT • iShares Commodities Select Strategy | 3% | +1 | 4% |
| EFV • iShares MSCI EAFE Value | 8% | -1 | 7% |
| IXG • iShares Global Financials | 2% | -2% | 0 |
| EFG • iShares MSCI EAFE Growth | 6% | -2% | 4% |
| IVV • iShares Core S&P 500 | 21% | +3% | 24% |
| IYE • iShares US Energy | 1.50% | +.5% | 2% |
| 100% Equity Model | |||
| IVV • iShares Core S&P 500 | 31% | 36% | +5% |
| IYE • iShares US Energy | 3% | 4% | +1% |
| EFV • iShares MSCI EAFE Value | 12% | 11% | -1% |
| EFG • iShares MSCI EAFE Growth | 9% | 6% | -3% |
| IXG • iShares Global Financials | 2% | 0 | -2% |
| 20/80 Model | |||
| No changes |
The Importance of Rebalancing
Most investors understand the difference, in principal, between focusing on the long term versus actively trading.
A concept that was popular several years ago was “buy and hold.” You still hear the term occasionally, as applied to investing for a long time horizon, but it’s not accurate, nor an approach that I recommend.
Here’s where I have a bit of an issue with the term “buy and hold”: Investors often take that to mean “set and forget.” In other words, just pick some investments and let them ride, whatever the market brings.
That’s really not much better than frequent day trading, and brings its own set of risks.
There are some basic tenets to consider when investing:
- First, you can’t just throw some random stuff into your investment accounts and call it a portfolio. Selecting your equity and fixed income investments must be done carefully, in line with your goals, risk tolerance, income and spending needs, and other factors.
- Second, this allocation of assets is not something you do once and then walk away, never to review your portfolio again.
This is where rebalancing comes in. Rebalancing is the process of taking profits from some of your investments that have run up, and reinvesting the proceeds into others that did not perform as well.
This isn’t something that necessarily happens every quarter. I’ve seen the quarterly rebalancing approach recommended, but there may be quarters where not much change is needed to keep your allocation percentages in line. Rebalancing in those cases amounts to no more than tinkering.
Instead, consider reviewing how far your allocations have moved from the original, predetermined targets.
For the purpose of a simple illustration, say your financial plan shows a recommended allocation of 18% large U.S. stocks. Imagine that domestic stocks enjoy a strong rally and now constitute 23% of your holdings. At that point, you would sell enough of the domestic stock fund to get that allocation back to 18%.
Meanwhile, a bond fund earmarked for 10% of your portfolio dropped down to 5%. You would reinvest the proceeds of the domestic stock sale back into that fund, to get your allocation back to 10%
You might feel pulled to let your winners run, and let less successful investments dwindle. That’s not a bad instinct, and you shouldn’t rebalance every time an asset class rises above its designated corridor.
Too much tinkering and trading leads you into market timing and messing with portfolio risk levels. You’re also letting emotions and opinions dictate your allocations instead of sticking with your plan.
Portfolio management isn’t an exercise in guesswork or fortune-telling. Nobody knows how various investments will perform at any given time, so shuffling around your holdings in anticipation of a rally or decline probably won’t yield the best return on a consistent basis.
It may feel counterintuitive to sell winning positions and funnel the proceeds into your poor performers, but that approach is consistent with the old advice to buy low and sell high. It sounds so simple, but isn’t always easy to do in practice.
This is why I take issue with investors who tout a pure buy-and-hold strategy without accounting for rebalancing. I’ve seen problems with taxable accounts, in particular, that were left unattended for years and resulted in big capital gains due to equity market run-ups. A disciplined approach to portfolio construction is a preferred way to increase the probability of the best outcome for your situation.