I have never believed that everyone needs a financial planner or a financial adviser.
Many investors are “do-it-your-selfers,” and this can work well. However, doing it yourself requires discipline, and I would never recommend a “set it and forget it” approach. An important task when managing your investments is to routinely rebalance your investment accounts.
In my view, rebalancing provides two major benefits. First, it forces you to pay attention to your investments and not neglect them. Second, it helps you maintain the target asset allocation you have chosen, which should be in line with your comfort level for risk.
I recommend rebalancing your investments accounts twice a year. You can schedule the rebalancing on a calendar basis, such as January 15 and July 15 each year. In addition, if the stock or bond market shifts significantly higher or lower, this should lead you to rebalance. For example, between Feb. 19, 2020, and March 23, 2020, the U.S. stock market (the S&P 500) plummeted 34%, as the severity of the COVID-19 pandemic became apparent. Amazingly, the S&P 500 recouped the losses by August 2020. For the full year of 2020 the S&P 500 had a positive return of 15.8%. Through May 31, 2021, the year-to-date return for 2021 has been approximately 12%.
How does stock market volatility impact an investment portfolio? While I was rebalancing my clients’ accounts in early 2021, I discovered many of them had become at least 5% heavy in equities (the stock market). If you have not rebalanced your accounts for a year or more, they may be as much as 15% to 20% heavier in equities than you intend. If left unbalanced, this situation could cause you to be more exposed to excessive risk, which equates to being overly vulnerable to the next stock market correction.
So, what are the steps required when rebalancing?
Review your target asset allocation
What asset allocation did you chose for your investments? This is based on your risk tolerance, and only you can decide what asset allocation you want to use as a target. As an example, do you want 50% of your account in equities (the stock market) and 50% in fixed income? Or do you want a higher or lower percentage in equities?
I tend to be conservative, and my primary goal for my clients is to protect their nest eggs rather than to focus only on growth. Many of my clients are retired. I believe a portfolio can grow very nicely without excessive risk. Although we cannot predict the future, conservative investors have been rewarded in recent years. According to Morningstar data a portfolio with 50% equities and 50% fixed income averaged an annual return of 6.3% during the past 20 years. Over the past 10 years, the 50/50 portfolio averaged an annual return of 10.9% (note that 10 years excludes the 2008 financial crisis).
Consider whether the asset allocation you have been using in past years is the same one you want to use moving forward. There are always concerns on the horizon for investors, and there are many now. Current worries include expected higher inflation, potential tax changes, and tremors in global and domestic stock markets caused by the pandemic. There are unknown factors that can impact the investment markets, such as natural disasters, terrorist acts, political turmoil and cyber security events. There are also concerns that the federal government has been propping up the equity markets in recent years and that we have not had a major correction in 13 years (since 2008).
I would add another concern to the list: Investors have been spoiled by quick recoveries in recent years, but I do not believe we should expect that to always occur. After the financial crisis that began in September 1929, the market took 15 years to recover; in September 2000, full recovery took six years; and in November 2007 (the beginning of the 2008 financial crisis), the market took four years to fully recover (per Morningstar data).
Should they stay or should they go?
Research each of your investments (using recent statements for your accounts) and determine if they still deserve a place in your portfolio. Has their performance in recent years been strong? Is the fee low? I keep my clients’ U.S. investments diversified between large-cap, mid-cap, small-cap and international, as well as between growth and value stocks. I prefer using no-load mutual funds with very low expense ratios, but exchange traded funds (ETFs) can also be used.
On the fixed income side of a clients’ portfolio, I make certain their bonds are also diversified. This may include a short-term bond fund as well as intermediate-term bond funds. The funds may focus on high-quality corporate bonds, treasury bonds, and international bonds. There are also “total” bond funds available. Bond ladders (using individual bonds) are sometimes used, depending on the client and their needs.
Sell any funds or holdings that you decide should not be in your portfolio. If these are in a taxable account you will need to consider the tax consequences (capital gains or losses). If they are in a traditional IRA or a Roth IRA, you do not need to be concerned about tax consequences.
Place trades and rebalance
After you have decided if you want to sell any assets or buy new ones, you will need to add up the percentage of equity funds and the percentage of bond funds. They should match the asset allocation you have chosen. For example, if you have chosen a 50% equity and 50% fixed income portfolio, the equity funds will need to add up to 50% of the total. If they do not, you need to make more changes until your investments match the target asset allocation you have selected. This is the essence of rebalancing.
If everything I have described is confusing to you, you may want to seek professional help. Some financial advisers work on an ongoing basis for clients, while others will work on an hourly basis. Many brokerage firms will provide financial advice for investors. If you are working with a financial adviser or stockbroker, ask if rebalancing is routinely being performed in your investment accounts.
I recommend that you work closely with your financial professional so you know why you own each investment and you are personally involved in managing your finances. Protecting your financial security (and not being a “sitting duck” during the next market correction) is worth your effort.
Donna Skeels Cygan, CFP, MBA, is the author of “The Joy of Financial Security.” She has been a fee-only financial planner in Albuquerque for over 20 years, and is the branch manager for the Mercer Advisors office in New Mexico. Contact her at email@example.com.