When and How to Rebalance Your Retirement Portfolio

Retirement Daily Guest Contributor

By George Padula, CFA

This is my favorite time of year. My backyard, which I mow myself (thank you very much), has a bit of hill and in the evening when the sun is setting, I have been known to sit and read with a favorite beverage until it is dark.

Last week was glorious. The weather was warm, not too humid and the sound of the alder leaves shifting in a light wind is soothing. One night this week after I finished painting my cornhole set, I read an article that profiled a few investors who sold everything and went to cash in March.

George Padula
George Padula

It got me thinking about rebalancing and why those investors either didn’t do so or even shift their equity allocation instead of selling everything. By going to cash, they eliminated any possibility of recovery until they start taking risk again.

Rebalancing is one of the topics that people talk about and consider, but for whatever reason, it doesn’t get done. It’s not due to lack of available research. The research on rebalancing is like the ocean and not a stream: broad and deep, not narrow and shallow.

One paper I just reviewed (high five to me) cited at least 16 other research papers on rebalancing. An MIT working paper entitled “Optimal Rebalancing Strategy for Institutional Portfolios” cites 19 rebalancing studies, and even Vanguard has several guides for best practices for portfolio rebalancing and getting your portfolio back on track with rebalancing. You can see where I am going. Rebalancing has been studied hard and there are some generally agreed-upon conclusions.

Benefits of rebalancing

To maintain the structure of the portfolio in line with its targeted investment allocation.

To prevent one from being overexposed to risky assets.

It can potentially enhance returns over time, especially when prices are declining.

It removes emotions from the decision process.

Rebalancing means that you are buying in when prices are lower and trying to take advantage of the recovery of those assets that had declined in price. It comes down to weighing a willingness to assume risk against expected returns and potential costs of rebalancing. With trading costs near or at zero, the actual costs are a lot lower now than they were when many rebalancing studies were conducted years ago. At the same time, there are opportunity costs, and even some tax costs to consider.

Fight or Flight

Even if we rationally grasp the benefits of rebalancing, why doesn’t everyone do it? It’s not always easy. Why? Because we’re human. When markets decline as sharply as they did in March, there is a desire to be in control, an overwhelming desire to do something, anything. But what? The fight or flight response kicks in and we tell ourselves “We need to do something now (SELL) to relieve the pain and quickly.” The fear part of our brain takes over and the easiest thing to do is bail out. Then there is the pile of cash just sitting there and no plan for what to do with it, or when to do something. It is hard. It is difficult to overcome emotions.

Enter Captain “Sully”

Being disciplined doesn’t just apply to investing. Having a plan is important in many areas of our lives and work. For examples, remember Miracle on the Hudson? When the engines on his plane went out, Captain Sullenberger referred to his training manual, procedures and experience to help him make the right decisions. Ultimately, he used skill and experience to glide his incapacitated plane to a water landing and save all passengers on board.

In the Apollo 13 accident, the astronauts and mission control staff had training manuals, made snap decisions based on those manuals, and used them plus their experience to bring the crippled capsule home. The 2009 book, The Checklist Manifesto by Dr. Atul Gawande, illustrates how checklists and trained processes can improve efficiency, consistency and safety in medical settings and as applied to the business world.

This is what we mean by having a rebalancing process and why it’s important to incorporate that into a disciplined investment strategy. Being disciplined, having an investment policy statement and a process ahead of time greatly enhance the ability to make sound decisions and not get caught up in analysis paralysis.

Ok, sounds like a great idea. Let’s rebalance. When?

Rebalancing may not be an exact science and one doesn’t need to rebalance exactly at the bottom or exactly at the top. Those are nearly impossible marks to hit.

While using the calendar, say every quarter or every year to rebalance makes the decisions easy, a calendar-based decision process could make one miss significant buying or selling opportunities. Rebalancing “dynamically” when relative weighting and valuations are pushed to extremes has been shown to be the most beneficial to a strict calendar-based methodology (For example, review research by Daryanani, Gobind, “Opportunistic Rebalancing: A New Paradigm for Wealth Managers.” Journal of Financial Planning, Vol. 21, No.1 (January 2008), pp.48-59).

Investors faced these dynamic opportunities this spring when the markets dropped quickly. We saw similar rebalancing opportunities several times in 2008 and 2009 during the financial crisis, in 2015 when high yield bonds and international equities hit extreme valuations and even late 2018 and early 2019 when volatility spiked. That’s what we mean by using a dynamic process and not being tied to a calendar approach.

Where to go for more information? Vanguard, Fidelity, Schwab and other custodians have materials and examples on rebalancing that review thresholds, goals and risks of rebalancing. Their overall conclusion in their studies is that rebalancing strategies can and should improve risk-adjusted returns.

We hope that gives you some insight on rebalancing. While it can seem that there can be an element of art and science behind rebalancing, the key is to understand that risk parameters can change, that having a plan and a process can be helpful and overcoming emotions in volatile time periods can be beneficial for reaching long-term investment goals.

About the author: George T. Padula, CFA®, CFP® 

George T. Padula, CFA®, CFP®, is Chief Investment Officer, Principal & Wealth Manager at Modera Wealth Management., LLC. He specializes in small business owners, college planning, retirement planning, endowments and foundations and charitable giving. George also oversees Modera’s Investment Committee.

George holds both the Chartered Financial Analyst® certification and the CERTIFIED FINANCIAL PLANNER™ certification. He earned a Master of Business Administration degree in finance from Boston College’s Carroll Graduate School of Management and a Bachelor of Arts degree from Colby College.

George is member of FPA, NAPFA, the Boston Security Analysts Society, the Boston Estate Planning Council and CFA® Institute. He also is on the Advisory Council for The Samfund.

Disclosures:

Modera is an SEC registered investment adviser which does not imply any level of skill or training. For additional information see our Form ADV available at www.adviserinfo.sec.gov which contains a full description of our business, operations and service offerings, registration status, and fees Please read the Disclosure Brochure carefully before you invest or send money.

This article is limited to the dissemination of general information about investment advisory and financial planning services that is not suitable for everyone. Nothing herein should be interpreted or construed as investment, legal, tax or accounting advice nor as personalized financial or tax planning advice or investment or wealth management advice. For legal, tax and accounting-related matters, we recommend you seek the advice of a qualified attorney or accountant. There is no guarantee that the views and opinions expressed herein will come to pass, and the information herein should not be considered a solicitation to engage in a particular investment or financial planning strategy.

Investing in the markets involves gains and losses and may not be suitable for all investors. Individual asset allocations and investment strategies differ based on varying degrees of diversification and other factors. Diversification does not guarantee a profit or guarantee against a loss. The statements and opinions expressed in this article are subject to change without notice based on changes in the law and other conditions.

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