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 mostpeople are likely unaware of the benefits from thissimple yet lucrative aspect of successful investing.
What is rebalancing?
To begin, determine your long-term financial goals and develop aglobally diversified asset class portfolio that supports reaching them.For example, if your investments must grow significantly in orderto comfortably sustain annual withdrawals throughout retirement,sufficient exposure to stocks may need to be maintained.
Once the proper asset allocation has been established for yourportfolio, each year some market segments will do better thanothers which will cause the original allocation to get out of whack.Rebalancing the portfolio merely gets it back aligned. This willinvolve selling funds (if you now own a higher percentage of thetotal than targeted) or buying funds (if it’s now lower). That’s it. Manyinvestors find January to be a good month to establish disciplinedannual rebalancing since they will know their portfolio is allocatedas intended at the start of every New Year.
Won’t that require selling some of my recent winners andbuying underperformers?
Absolutely, which is the whole point -- regularly selling high andbuying low. What drives profits for businesses applies equally to yourinvestments. That’s why it is also important to avoid costly funds aswell as taxes generated by frequent trading since every dollar spenton costs and taxes is a dollar less earned from the investments. Toillustrate, suppose your asset allocation is currently 60% stocks and40% bonds. Then, after a good year for equities, the allocation driftshigher to 70% stocks and 30% bonds. Rebalancing would entailselling some of the stock exposure and using the proceeds to buybonds, 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 ofmarket timing decisions (that are often misinformed) in exchangefor a more proven behavior. The portfolio will not wander off fromintended allocations which helps contain risk exposure and alsoleads to more reliable results. Regularly selling securities for gainscontributes to a positive investment return while providing proceedsto buy more of funds that are relatively cheaper, thereby contributingto additional future gains. Plus, the portfolio is kept at a risk level theinvestor is likely more comfortable with.
As a bonus, you’ll usually end upwith more money over the longrun which increases the rewardfor saving and investing. Studieswe conducted for rolling 20-yearperiods since 1979 with a multi assetclass portfolio showed that annual rebalancing led to a higher ending total andlower risk/volatility about 80% of the time comparedto equivalent portfolios left unattended. The averageincrease was more than 1/3 of the original balance.
In other words, on average, regularly rebalancing a starting $500,000portfolio 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 allocationthat will reliably achieve your long-term goals.
- Second: Stick with the strategy despite periodic market volatilitywhich is unavoidable and unpredictable.
- Third: Utilize low cost, tax efficient funds to keep more money inyour pocket.
- Fourth: Rebalance annually.
Is this strategy easy to manage and commonly done?
In a word, no. Developing an intelligently diversified, low-costinvestment portfolio that will reliably achieve your long-term financialgoals can be quite a task. Furthermore, not only is remembering torebalance the same time each year challenging, actually sellingfunds that have been your best winners and then using the gainsto buy recent losers is understandably more than most folks canstomach. After all, when stocks plummeted 50% during the recent2008 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 rebalancedback to its strategic allocation in order to maximize the probabilityof reaching your cherished long-term goals.
*Analysis: Canandaigua National Bank & Trust; Hypothetical example based on lumpsum 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. Investments and insurance products are not FDIC insured, not bank deposits, not obligations of, or guaranteed by Canandaigua National Bank & Trust or any of its affiliates. Investments are subject to investment risks, including possible loss of principal amount invested. Past performance is not indicative of future investment results. Before making any investment decision, please consult your legal, tax or financial advisor. Investments and services may be offered through affiliate companies.
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.
FAQs
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.
What is the 5/25 rule for rebalancing? ›
It states that rebalancing between assets should occur only if an asset or category has drifted from its original target by an absolute percentage of 5% or a relative of 25% whichever is less.
What is a perfect market timing strategy? ›
A perfect market timing strategy needs to know, with certainty, the future returns of the assets that are eligible for investment. Armed with this information, the perfect market timing strategy always chooses the highest returning asset to invest in.
Is rebalancing a good strategy? ›
Having an asset allocation that is appropriate for an investor's goals is important, and periodic rebalancing helps keep a portfolio in line with its allocation target.
Is it better to rebalance when the market is down? ›
You should consider adopting a portfolio rebalancing strategy—even during down markets when it's tempting to let your “winners” keep growing while your “losers” are taking their lumps. That's because rebalancing helps you buy low and sell high—an investing adage that's easy to say and hard to do.
What is the 10 5 3 rule of investment? ›
Understanding the 10-5-3 Rule
The 10-5-3 rule is a simple rule of thumb in the world of investment that suggests average annual returns on different asset classes: stocks, bonds, and cash. According to this rule, stocks can potentially return 10% annually, bonds 5%, and cash 3%.
What is the 1234 financial rule? ›
One simple rule of thumb I tend to adopt is going by the 4-3-2-1 ratios to budgeting. This ratio allocates 40% of your income towards expenses, 30% towards housing, 20% towards savings and investments and 10% towards insurance.
What is the most consistent trading strategy? ›
“Profit Parabolic” trading strategy based on a Moving Average. The strategy is referred to as a universal one, and it is often recommended as the best Forex strategy for consistent profits. It employs the standard MT4 indicators, EMAs (exponential moving averages), and Parabolic SAR that serves as a confirmation tool.
What is the biggest risk of market timing? ›
The biggest risk of market timing is usually considered not being in the market at critical times. Investors who try to time the market run the risk of missing periods of exceptional returns. It is very hard for investors to accurately pinpoint a market high or low point until after it has already occurred.
Is market timing better than buy-and-hold strategy? ›
Research shows that long-term buy-and-hold tends to outperform, where market timing remains very difficult. Much of the market's greatest returns or declines are concentrated in a short time frame.
Smart Rebalance is a classic strategy that has been used for decades in the traditional industry. The core of the strategy is to increase the total amount of assets by selling high and buying low, at the same time maintaining the portfolio basically unchanged.
What are the downsides of rebalancing? ›
Active rebalancing can also be expensive, as it involves trading fees and potential taxes. Each time an asset is bought or sold, investors must pay a trading fee or transaction costs. These fees can add up quickly, especially if an investor is frequently rebalancing their portfolio.
What is the rebalancing bot strategy? ›
What is the Rebalancing Bot? The Rebalancing Bot will automatically adjust your portfolio position in the token combination of your choice. By buying low and selling high, your strategy can maintain the same ratio of asset values through rebalancing at preset intervals or thresholds.
Does Warren Buffett rebalance? ›
David Kass, a professor of finance at the University of Maryland, said most professional investors like Warren Buffett do not rebalance, but it makes sense for the rest of us.
What is the 5% portfolio rule? ›
This is a rule that aims to aid diversification in an investment portfolio. It states that one should not hold more than 5% of the total value of the portfolio in a single security.
How often is the S&P 500 rebalanced? ›
The frequency of index rebalancing depends on the index in question. Some indexes, like the S&P 500, are rebalanced quarterly, while others are adjusted semiannually or annually.
How do I avoid taxes when rebalancing? ›
If you do your rebalancing in a tax-deferred account, like a pre-tax 401(k) or even a tax-exempt account like a Roth IRA, you'd steer clear of any tax whatsoever. This is because these retirement accounts are subject to special rules that allow you to avoid taxation once money is in the account.
What is the best frequency for rebalancing? ›
Monthly and quarterly assessments are typically preferred, because weekly rebalancing would be overly expensive and a yearly approach would allow for too much intermediate portfolio drift. The ideal frequency of rebalancing must be determined based on time constraints, transaction costs, and allowable drift.
What is the 5/25 rule for mutual funds? ›
Let's start with the 25:1 and 50:5 rule, a sort of “bright line test” with two simple guidelines: One issuer cannot contribute more than 25% of the portfolio's fair market value. Five or fewer issuers cannot contribute more than 50% of its fair market value.
What percentage should you rebalance your portfolio? ›
There is not a hard-and-fast rule on when to rebalance your portfolio. But many investors make it a habit to revisit their investment allocations annually, quarterly, or even monthly. Others decide to make changes when an asset allocation exceeds a certain threshold such as 5 percent.