Why your portfolio may be overdue for a rebalance


rebalanceThe market has been on a tear since the election.  According to Bloomberg, the rally has added over $2.8 trillion in value to the U.S market and we witnessed 12 consecutive “up days” in February – a feat that was last surpassed in 1987.   Not only have we witnessed a significant increase in value, we have also experienced a decline in overall volatility (down 34 percent in the last year and near all-time lows), leading some analysts to suggest that we are eventually overdue for some bumps in the road. 

Is the market overvalued?

Many conventional measures of valuation such as PE ratios (forward, trailing & CAPE) generally suggest that values may be getting frothy. Some analysts may argue that low interest rates support elevated valuations.  However, the Federal Reserves is expected by many to continue hiking interest rates in the coming year.  While measures of market value have often been poor predictors of short-term movements in the market, they can highlight when prices get elevated.    

The question becomes what should investors be considering at this point? Despite the recent moves in the market and the extended length of the current bull market (approaching 8 years), market timing is generally not recommended or advisable.  However, it may be an appropriate time to take a step-back and examine your current portfolio to ensure you are properly allocated for your unique goals.  

Rebalancing your portfolio

An often-overlooked tool that may be effective in helping to manage risk is the process of portfolio rebalancing. The rebalancing process, when implemented correctly, is designed to help bring the different investments that make up an investor’s portfolio back into proper alignment. As the markets fluctuate over time and certain components of the portfolio over-perform and under-perform, the original investment mix changes, altering the amount of risk in the portfolio.

For example, an investor with a traditional 60 percent equity and 40 percent fixed income portfolio that hasn’t been rebalanced in a few years could now have closer to 70+ percent in equities.  This may leave investors with a risk profile that may no longer be in alignment with their goals or comfort level.

Rebalancing may help investors accomplish a feat that many find difficult to execute — buying low and selling high. It also requires discipline to sell investments that are performing well while exchanging them for others that may have underperformed. Unfortunately, many investors fail to review and rebalance their investments with any regularity. 

Three T’s of rebalancing

There are many important considerations when determining an appropriate rebalancing strategy - there is not necessarily a “one size fits all” approach.  Despite the importance of implementing an approach that works for you, the three T’s of rebalancing — timing, taxes and transaction costs — all affect the decision-making process.

First, let’s examine the timing.  One approach to rebalancing is based upon choosing a time frame — quarterly, semiannually, or annually to rebalance the portfolio back to the original mix. While some investors find value, and appreciate the simplicity of this approach, others see the merits of rebalancing based upon certain portfolio targets. For example, choosing to rebalance when any portfolio holding is 5 percent above or below the original target allocation.  Let’s assume an investor had an original portfolio consisting of 70 percent in stocks and 25 percent in fixed income and 5 percent in cash. If the stock portion increased to greater than 75%, a rebalance would occur that would reset the portfolio back to the original target allocation. 

Many analysts have noted the advantages of a combination of the two approaches. In fact, Vanguard noted in its rebalancing study that a strategy based upon a semiannual or annual review in combination with the usage of a 5 percent deviation, may be ideal in controlling risk for diversified portfolios over the long-term.

Next, it is important to review the tax implications. Remember, choosing to buy or sell investments outside of a retirement account may result in a capital gain or loss and long-term and short-term gains will be taxed differently. Since you do not have to worry about capital gains taxes in a retirement account, it may make sense to begin there. Consult your tax adviser to determine the tax impact of rebalancing any taxable accounts before you move forward.

Lastly, it is important to consider the impact of sales commissions, transaction fees or other ticket charges as they can create a drag on investment returns. Rebalancing too often can result in higher taxes and transaction fees.

When was the last time you rebalanced your portfolio?  Is your target allocation in alignment with your life? Now may be the time to review your accounts and consider the benefits of rebalancing. Keep in mind that rebalancing does not prevent losses or assure profit and each investor should carefully consider their risk level and goals by reviewing their situation with a financial adviser.

 Kurt J. Rossi, MBA, CFP®, CRPC®, AIF® is a CERTIFIED FINANCIAL PLANNERtm Practitioner & Wealth Advisor.  He can be reached for questions at 732-280-7550, kurt.rossi@Independentwm.com, www.bringyourfinancestolife.com & www.Independentwm.com. LPL Financial Member FINRA/SIPC.