Should You Rebalance Your Portfolio?

Portfolio Rebalancing

Do you ever read an article that just kind of makes you kind of tense up and go, “Oh!” 😬

You tense up and you don’t like it. If you’re like me today, no matter what side of the fence you’re on, you can continually read articles that cause that knee-jerk reaction inside of you. However, good news, we’re not talking about all the common things you might think I’m referring to today, nothing about COVID, or the election, or anything else. 

The article I’m talking about said this, it said rebalancing is still everyone’s greatest risk management strategy. Then I had that reaction. To me it is almost like saying letter writing is still everyone’s best form of communication. Really? We have phones, we have email, we have Facebook, we have all kinds of things now, right?. Yes, it’s still great to send a card or letter but to say that it’s still everyone’s best form of communication? We know it’s not true. So, rebalancing? Everyone’s best form of risk management? Yeah, I think there’s more to the story.

What is rebalancing? 

Let’s take a second and think about it. Rebalancing is the process of buying and selling portions of your portfolio in order to set the weight of each asset class back to its original state. Essentially what it’s doing is saying hey, you put together your Investment portfolio, your pie charts so to speak. You’re probably all familiar with looking at statements and seeing that pie chart. It might say for example, 60% stocks and 40% bonds. The 60/40 portfolio has gotten a lot of attention as a great, modern portfolio or conservative portfolio. Good for someone in retirement. We’ll talk about that more in a bit. 

Rebalancing says, okay now the stocks have done better, bonds were a little down, so now we have 70% stocks, 30% bonds, and we need to rebalance to get back to that 60/40. That’s more of an extreme example, but that’s really what it’s saying. Inside of that stock account are those bonds accounts and you have multiple different funds or accounts and it’s just basically saying hey this one performed well, this didn’t, but we’re going to rebalance and put the same in all of them, or put our desired percentage. 

Is rebalancing necessary?

Okay, so let’s think about this for a second. The thought here is that this one performed well this year and this one didn’t, so we’re going to rebalance them again because this one might perform better next year or we don’t want to have too much in here. 

That same line of thought made me think of a similar comparison. Now, think about your garden. I don’t care if it’s your flower garden, your vegetable garden, or whatever. You know if you want to keep that garden looking good then you have to go out and do the dreaded job of pulling weeds. 

I just did this for my hosta garden. Hostas tend to be the one plant that I don’t kill very well, but every now and then they still need to be weeded. Just the other day I was pulling out all kinds of weeds from the hosta garden. Why? We pull out the weeds so that our plants, the flowers, the hostas, the vegetables, whatever, can grow. We don’t want you to keep the weeds in there because they will inhibit the good plants from growing. 

So then why, when it comes to the market rebounds, would we want to put more towards the bad? Just think about it like fertilizing your yard. We have weed and feed which means we want to get rid of the weeds and feed the grass or feed the flowers. Weed and feed. Get rid of the losers and then keep, encourage, and nurture the winners. 

The same idea should apply to rebalancing. It should take from the winners, take from the flowers, and give to the losers. Not necessarily a good concept all the time, right? We don’t always want to take from the winner and give it to the loser.

Now, unlike flowers where a weed is always a weed, when it comes to the market, one thing that might be good now might not be so good later, and vice-versa. 

Let’s just think about this for the moment. We know that this year in 2020 there are certain industries that have been hit hard because of the pandemic. The travel industries, restaurants, etc. are not up to their full capacity. They’re struggling. They’re not doing well right now. They’re not “the winners.” 

However, there are other Industries in the other sectors that are poised to do really well. Some examples include the companies that are making medical supplies, masks, or a company I learned about from a friend that makes cleaning products that kill COVID. That’s a great company to be right now. Everyone in the world is looking for that.

So, at any given time there’s going to be certain companies in industries that are poised to do better and some that will do worse. We don’t want to rebalance and give everybody the same. That’s where the idea of smart rebalancing comes in.

What is smart rebalancing?

Smart rebalancing is the idea where you look at what is going on right now. What is currently happening in our world? This strategy looks for the areas of strength and the areas of weakness. It gets rid of the weakest or limits the weakest and then it nurtures the strong industries. That’s what we want to do. We don’t want to just blindly rebalance. 

To utilize the method of smart rebalancing there’s a stress test that’s involved. What if everything shuts down again? What if interest rates fluctuate? The stress test is in place to figure out what is currently going on that could affect your portfolio and then balances your portfolio out while continuing to always look at rebalancing as things change with time. 

We don’t set it and say hey we’re going to be in this industry for this sector and then leave it forever after a poor performance because next year things might be reversed. Maybe everything changes and now everyone wants to travel because we have been sick of being at home. Then the travel agencies are to trend high or the airlines and all the travel industry is going to go crazy. So yes, we need to rebalance, but we need to rebalance smartly and based on what’s currently happening rather than blindly feeding the winners and losers at the same time. 

What if I currently have a 60/40 portfolio?

Now, let’s revisit that 60/40 portfolio that I mentioned earlier. If that’s what you have, or that’s what you’ve been told, and that’s what you think is best, you might feel reassured. You have the 60/40 portfolio and they have rebalanced, so you might think you’re good, you’re safe, right? It’s a good conservative mix. 

Well, you may not have thought of this. The potential issue is that this 60/40 setup has made us develop a line of thought that when stocks do worse, then bonds will perform better. It makes you think that they aren’t connected or they’re not working in the same way. 

That way of thinking really changed this year. If you remember when the market hit, when that pandemic really struck, the stocks went down and so did the bonds. A 60/40 portfolio can be compared to a parachute that might not open when you need it to. It is not a good form of risk management strategy. 

How do I make changes to my portfolio?

So, if you have that type of portfolio, or you feel comfortable with being rebalanced and think that you’re fine, then it is time to talk. We really need to talk. Let’s talk about some alternatives and let’s do some stress tests. We have a great team in place to help stress test your portfolio, identify the losers and help you to feed the winners? Where is your portfolio at? Then you will know what to do. 

I remember that I had to do that with my “flower garden” when I first bought this house. I looked back and it looked like a jungle to me. My Aunt comes over and she’s like, “Well, you’ve got this and this and this and it all looks so great,” and I’m like, “Yeah, um to me, I don’t know what to pull and what not to pull.” Hence I got rid of it all and planted hostas. 

Granted, you might not want to do that with your portfolio, but you might need somebody to come and say, this is good, this isn’t good, you’re not set up right now to be safe, or you have a lot of risk. But, if we run these “What if?” scenarios then we can identify your “losers,” we can say here are the weeds that need to be pulled. Here’s the strength that we need to go to. 

Let’s Talk About Your Portfolio

So, maybe you have a green thumb and could have helped me with my flower bed, but you’re looking at your Investments and going, “I don’t know what to do.” 

If that’s the case, make sure just give us a call. Don’t just trust that rebalancing is your only and the best way to risk-manage your portfolio, as there are far different and in many cases, better ways to successfully manage your portfolio. 

Stay tuned as we talk more about it, but in the meantime, if you have questions please pick up the phone, give us a call, and we’ll walk you through it. We will help you figure out how to stress test your portfolio so that you get rid of the weeds and grow the flowers.