The most common advice investors have gotten thus far in 2022 seems to be: “This is a good time to rebalance your portfolio.”
It started right around New Year’s Day, because plenty of people simply hold fast to the idea that the start of a new year is the perfect time to rejigger a portfolio back to its target weightings.
It also was popular because as investment experts gave their outlooks for the year ahead, they expected reduced performance in large-cap domestic stocks — which were up over 25 percent last year — and improved results from international investments and smaller companies.
Then, as the stock market suffered through a volatile and negative January, rebalancing was the keyword again as experts suggested locking in gains and getting ahead of market rotations, a thought that has continued into February as tensions have escalated on the Russia-Ukraine border and inflation has threatened to go even higher.
Through all of that, rebalancing — the act of culling your leaders and using the proceeds to seed your laggards in order to put an asset allocation back on track — is emotionally hard.
Taking some winnings and putting it to your laggards feels like a famous line from legendary investor Peter Lynch in his book “One Up on Wall Street”: “Selling your winners and holding your losers is like cutting the flowers and watering the weeds.”
Going a bit further, I will let you in on one my secrets as a personal finance journalist: Despite talking about rebalancing for decades, I have never actually done it myself.
Don’t be outraged by that, because I do live by the advice I give. It’s just that I invest new monies in line with my asset allocation plan; there’s no need to rebalance if you never get off balance.
The hard part for me comes from “selling winners”; I’m hardly immune from the emotion behind “Let the good times roll.”
The part that feels difficult to most people — but that I find easy — is investing into asset classes that I need to beef up. The trick is that I don’t consider it “investing in laggards” so much as strategically beefing up the portfolio’s weaknesses.
It’s a fine-line distinction maybe, but it works for me.
Whether you rebalance or simply maneuver in-flows to stay on track with your investment plan, the key thing for investors right now is to understand their asset allocation and to make sure it properly accounts for current conditions.
That’s why the right advice now should focus less on rebalancing and more on evaluating your entire allocation plan from the ground up.
There are countless studies in the investing world harping on the importance of asset allocation, having a plan and sticking to it. The vast majority of your investment returns are a result of asset allocation, much more than the securities you buy and the timing of 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 registered a 28 percent gain on the index in 2021. The 50-50 portfolio – with cash earning virtually nothing – returned half that amount.
What’s more, the 50-50 investor — thanks to the market’s gain — ended the year with 56 percent of the portfolio in stocks, and just 44 percent in cash.
Common financial advice suggests that once a portfolio is five to 10% off of the plan, it’s time to rebalance, thus “selling the winners” and going with the laggards [or, in my case, putting the new money into the under-represented part of the portfolio].
And here is where investors must now go beyond rebalancing to review the full asset allocation.
The hardest thing for investors to do — the number one job for a financial adviser — is develop emotional discipline, the ability to have a plan and stick to it in all conditions.
But plans, like markets, change, and while today’s investors don’t want to get hyper-focused on current events, they must take them into account.
In the current inflationary environment, people in their 20s and 30s worry primarily about how higher prices are hitting them in the grocery store or the housing market. People above the age of 50 and/or in retirement aren’t worried about the cost of eggs now, but are petrified that they won’t have enough money to afford breakfast in their dotage.
If someone were to hire a financial adviser and start the asset-allocation process today, inflation and purchasing-power risk would be a much larger factor than it has been for the last three decades.
If someone has a plan they have lived on for decades, they must ensure that it’s correct for the current and future environments we plan for now. They also may want to adjust it for investment products and developments that have come to market over those years.
Much like a stock or mutual fund investor should think like a buyer and ask “Would I buy this again today?” — rather than placidly holding on forever as an owner — an investor should review their allocation and say “Is this the plan I would make today?”
I recognize that you’re not “following a plan,” if you upset the apple cart and start all over again.
But investors have been saying for years that classic 60-40 stock/bond allocations don’t work because low interest rates have hampered fixed-income securities. They’ve let things ride — and maybe avoided rebalancing — rather than re-examine the plan.
So if market conditions have made you nervous about your investments, stop looking at the securities and start re-examining the plan. Adjust it for current conditions not only in the market but in your life.
Only then can you determine if the market should have you culling your winners, supporting your laggards and feeling certain that the plan can achieve your financial goals.