By: Kelly McNerney
Buy low; sell high.
Despite the proven benefits of this time-tested investment strategy, many people still find it hard to stomach. You may be one of them.
A look at the sound reasoning behind this fundamental portfolio builder may strengthen your resolve.
We use the term “rebalancing” when we apply the buy low/sell high strategy to a client’s portfolio. Rebalancing means selling investments that have outperformed and adding to investments that have underperformed. When an asset outperforms, it produces higher returns relative to other investments in the portfolio, i.e., the Dow Jones Industrial Average, the S&P 500, or NASDAQ. Conversely, when an investment underperforms, it produces lower returns than the overall market.
How Does Asset Allocation Complement Rebalancing?
Rebalancing can be less nerve-wracking when your portfolio already reflects your investing style. The foundation of creating a portfolio that reflects your long-term investment strategy is to set a target asset allocation.
Asset allocation aims to balance risk and reward by apportioning the assets in your portfolio (stocks, bonds, real estate, etc.) according to your investment horizon, financial and life goals, and risk tolerance. There are many online tools available to get you started on determining the right asset allocation for you.
When we assist clients with their portfolio mix, we ask them to consider:
- Time horizon: When will you need to start withdrawing your money? How much will you need to withdraw, and at what intervals? How long will the money need to last you when you begin to withdraw it?
- Personal goals: How much money do you aim to accumulate? How do you intend to use your money, and what are your top priorities?
- Risk tolerance: How comfortable are you during market ups and downs? Are you willing to implement a strategy even if it makes you uncomfortable? The recent market volatility has been a true test of investors’ risk tolerance. If the downturns caused you sleepless nights and anxiety, you might want to revisit your risk tolerance and short-term needs.
At FJY Financial, we believe in a disciplined approach to long-term investing. That includes setting target allocations so clients can stick with their investment strategy through an entire market cycle and weather the ups and downs along the way. When a portfolio is not within its target allocation, we rebalance to trim from what has outperformed and add to what has underperformed (see charts below).
This may seem counterintuitive to you. Why sell the “winners” and buy the “losers”? The answer is that buying what has underperformed is comparable to scooping up that asset class when it is on sale. You can afford to buy more shares of the position. When the underperforming asset class rebounds, you reap the rewards. The same is true in the opposite direction. As an asset class outperforms, you take your gains off the table and decrease your exposure to an asset that is on the way down.
When Is the Right Time to Rebalance?
We typically rebalance client portfolios when there is a 10% deviation from the target asset class. There are exceptions to this rule, of course, including keeping within your individual, narrower comfort zone, an outstanding market opportunity, or an unexpected life circumstance that shifts your investment outlook.
At FJY Financial, our expert advisors view rebalancing to take the emotion out of investing for our clients. If you would like to talk about a holistic approach to your finances with a focus on your personal goals and priorities, feel free to reach out. We have an array of digital tools and security protocols to put health and safety first during pandemic conditions.