The Importance of Rebalancing and, yes, it’s important

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It is hard to believe – but we’re already through the first quarter of a new year. As 2021 came to a close, we spent some time reflecting on the past year and built a checklist for this year.

In many ways, this reminded us of a tool that we use to help our clients stay efficient in their portfolios and long-term goals.

As we have discussed at length in previous articles, we are staunch believers in understanding and knowing your individual risk tolerance for your investment portfolio. In other words, it is vital to know how comfortable you are with the risk in your portfolio. Of course, there is always a risk when investing, whether in the stock market or bond market. However, historically stocks have been riskier and more volatile than bonds. Investment portfolios are subject to market swings in both directions that can cause an investment portfolio to runup or drawdown.

Rebalancing your portfolio is something that is found on our year-end checklists to discuss with clients because of how important risk tolerance and portfolio allocation is to success as a retirement investor. In this article, let’s look at rebalancing and how it can help you continue to move the needle toward your retirement.

What rebalancing means

First, you need to understand what rebalancing means for your portfolio. Rebalancing, at a technical level, is the selling of a portfolio’s top performers to buy the worst performers back systematically. There are different frequencies in which investors rebalance their portfolios ranging from quarterly to annually. Given that 401(k) and retirement accounts are not subject to the capital gains tax, rebalancing is an advantageous way to maintain your asset allocation and overall risk tolerance in both bull and bear markets without having to worry about additional penalties or taxes.

But more than that, rebalancing also can help provide you with a peace of mind and confidence that your portfolio is appropriately weighted and allocated to suit your specific needs as an investor.

Rebalancing impacts portfolios in positive ways in both up and down markets. When the market is continuously driving up – a bull market – the stock or equity piece of an investment portfolio can increase and cause an investor to be overallocated. In turn, as a bull market extends, that same investor owns the risk of a more extreme drawdown in their portfolio if they leave it unchecked. Enter a rebalancing strategy.

By rebalancing the portfolio back to the original allocation, the investor takes advantage of the run up of the market and maintains his or her individual risk tolerance.

Rebalancing can be and is used during bear markets. While generally more painful due to equities falling faster than bonds in most cases, rebalancing helps portfolios during these times in the long run.

The pace of retirement

We often say that retirement planning is a marathon not a sprint. As an equity allocation increases and is not rebalanced during a bull market, the impact of a bear market on that portfolio is multiplied. As a result, the time it takes for that same equity allocation to recover is extended.

The bottom line is portfolios that do not rebalance systematically are subject to longer recovery periods than those that do rebalance over time. There are many factors that go into building a successful retirement plan. You need time and patience, a long-term goal, an investment strategy, and many other things.

But perhaps the most important is discipline to stick to your investment strategy. Part of that process is rebalancing your portfolio systematically over time.

A friendly reminder that your advisor or plan representative works for you. Never hesitate to give him or her a call or email to discuss questions you may have about your retirement plan or investment portfolio.


Article Written By David & Vance Wentz

David Wentz is CEO of TFB, Inc. David frequently speaks at various seminars about profit sharing, 401(k) plans and investment programs. Vance Wentz is an advisor with TFB, Inc. Vance graduated from Kansas State University with a degree in finance. The Western Equipment Dealers Association endorses Tax Favored Benefits as a 401(k) provider. No compensation is received. More information is available at www.taxfavoredbenefits.com.

 

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