The most common advice investors have received so far in 2022 seems to be, “It’s a good time to rebalance your portfolio.”
It started around New Years Day, as many people simply cling to the idea that the start of a new year is the perfect time to bring a portfolio back to its target weightings.
It was also popular because, as investment experts gave their outlook for the year ahead, they expected a decline in the performance of large-cap domestic stocks – which rose more than 25% last year. – and an improvement in the results of international investments and small businesses.
Then, as the stock market suffered from a volatile and negative January, rebalancing was once again the key word as experts suggested locking in gains and anticipating market rotations, a thought that caught on. continued in February as tensions escalated on the Russian-Ukrainian border and inflation threatened to go even higher.
Through it all, rebalancing — the act of eliminating your leaders and using the proceeds to seed your laggards to get an asset allocation back on track — is emotionally difficult.
Taking gains and handing them over to your laggards sounds like a famous phrase from legendary investor Peter Lynch in his book “One Up on Wall Street”: “Selling your winners and retaining your losers is like cutting the flowers and watering the bad ones. herbs.”
Going a little deeper, I’ll let you in on one of my secrets as a personal finance journalist: Although I’ve been talking about rebalancing for decades, I’ve never done it myself.
Don’t be outraged by this, for I live by the advice I give. It’s just that I invest new funds according to my asset allocation plan; there is no need to rebalance if you never lose balance.
The hardest part for me comes from “selling winners”; I’m not immune to the emotion behind “Let the good times roll”.
The part that seems difficult to most people – but that I find easy – is investing in asset classes that I need to strengthen. The thing is, I don’t see it so much as “investing in the laggards” as strategically reinforcing portfolio weaknesses.
It might be a fine distinction, but it works for me.
Whether you’re rebalancing or simply maneuvering inflows to stay on track with your investment plan, the key for investors right now is to understand their asset allocation and ensure it properly takes into account current conditions.
This is why good advice should now focus less on rebalancing and more on evaluating your entire allocation plan from scratch.
There are countless studies in the investment world that stress the importance of asset allocation, having a plan and sticking to it. The vast majority of your investment returns come from asset allocation, more than from the securities you buy and when you buy them.
Consider two people who invest solely in a Standard & Poor’s 500 index fund for their equity exposure. One is all-in – 100% in stocks – while the other is split 50-50 between the index fund and cash.
The all-in investor saw a 28% gain on the index in 2021. The 50-50 portfolio – with cash yielding next to nothing – returned half that amount.
Moreover, the 50-50 investor – thanks to the market gain – ended the year with 56% of the portfolio in stocks and only 44% in cash.
Common financial advice suggests that once a portfolio is 5-10% below plan, it is time to rebalance, thus “selling the winners” and leaving with the laggards. [or, in my case, putting the new money into the under-represented part of the portfolio].
And this is where investors must now move beyond rebalancing to reviewing the full asset allocation.
The hardest thing for investors to do – job number one for a financial advisor – is to develop emotional discipline, the ability to have a plan and stick to it under all conditions.
But plans, like markets, change, and while today’s investors don’t want to be hyper-focused on current events, they need to take them into account.
In today’s inflationary environment, people in their twenties and thirties worry primarily about how higher prices will hit them at the grocery store or in the housing market. People over 50 and/or retired don’t worry about the cost of eggs now, but are petrified that they won’t have enough money to afford breakfast at their age.
If someone hired a financial advisor and started the asset allocation process today, inflation and purchasing power risk would be a much bigger factor than they have been in the last few years. last three decades.
If someone has a blueprint they’ve been living on for decades, they need to make sure it’s correct for the current and future environments that we’re predicting at the moment. They may also want to adjust it to investment products and developments that have come to market during those years.
Just as a stock or mutual fund investor should think like a buyer and ask, “Would I buy this again today?” – rather than remaining placidly forever as owner – an investor should review their allocation and say “Is this the plan I would make today?”
I recognize that you are not “following a plan” if you knock over the basket of apples and start over.
But investors have been saying for years that the classic 60-40 stock/bond split doesn’t work because low interest rates have hurt fixed-income securities. They let things happen – and perhaps avoided rebalancing – rather than reconsidering the plan.
So if market conditions are making you nervous about your investments, stop looking at the headlines and start re-examining the plan. Adjust it to current conditions not only in the market but also in your life.
Only then can you determine whether the market should have you eliminating your winners, supporting your laggards, and being confident that the plan can achieve your financial goals.