Many investment firms recommend a periodic rebalancing of one’s portfolio. Let’s look at what rebalancing means and why you’ll not see me taking their approach.
What does it mean to rebalance a portfolio?
Rebalancing a portfolio is an asset allocation strategy. Assets (stocks and bonds) are categorized, assigned “optimal” target percentages, and then periodically reallocated to bring assets back to their target percentages.
A typical investment portfolio allocation is 60% stocks and 40% bonds. (Read why the 60-40 portfolio should be obsolete here.) Investments in each category may be further diversified by sector or class. For example, the 60% stock allocation might be split into 20% small-cap stocks, 20% international stocks, and so on.
Let’s say that, over a six-month period, international stock values go up and now represent 30% of the overall stock portion of the investment portfolio. A rebalancing strategy requires selling enough investments in international stocks to bring it back down to its “optimal” 20% target. That cash is then reallocated towards other investment areas that fell below their target percentages in the same period.
Simply put, rebalancing is the periodic reallocation of portfolio assets (like every quarter, six months, or year) to reflect “optimal” portfolio percentages.
Why is rebalancing a portfolio a poor strategy?
Many firms will generate what they call your “risk profile” from a questionnaire. They use this profile to suggest to you an “ideal” allocation for your investments. But, don’t be lulled into a false sense of comfort or precision by their charts and graphs (which you’re probably paying high fees for, by the way). Instead, understand what rebalancing is meant to do.
Rebalancing is a risk management tool – not a source of enhancing returns.
Said another way – these strategies reduce your risk enough to get you to stay in your investments and with their firm.
- A questionnaire cannot identify your “optimal” investment percentage for a particular asset. Such precision simply doesn’t exist in the real world. It’s like filling out an online dating questionnaire and being told the resulting match is your “ideal” mate. If you’re anything like me, you’d probably have your doubts – and you’d be right.
- Past data cannot be used to build your “optimal” investment model for the future. For rebalancing to work optimally, the future has to somewhat mirror the past – because past data is the only data we have. The problem is that today’s data doesn’t resemble anything that has transpired in the past. Today, bonds and certain stock categories are at historically high prices. We’ve simply never experienced both stocks and bonds being this expensive at the same time. No 60/40 model could address this phenomenon through rebalancing.
- Rebalancing requires you to put money into sectors that might be expensive or overvalued. For instance, most of these strategies include an allocation to corporate bonds. We believe that the corporate bond market today is so fraught with risk that investors should totally stay away. Just a little inflation or increase in interest rates and it could take a decade or more to recover your original investment in a corporate bond fund. It’s like picking up nickels in front of a steamroller. You can make a little money, and then one day… splat.
In short, firms that use asset rebalancing strategies are admitting to losing the thinking man’s game. Their charts and graphs are likely based on faulty data or invalid assumptions. They are signaling an ignorance or unwillingness to thoughtfully manage high and low-performing assets.
Do you want to pay someone to manage your investments who can’t make a determination and just sticks your hard-earned funds into a model?
If CSH doesn’t rebalance portfolios, then what do you do?
At CSH Investment Management LLC, we do reallocate our clients’ portfolios but on an individual basis and with great thought.
Take Microsoft stock for example. In the decade we’ve owned Microsoft stock, its value has grown from $20 to $335 a share. If we had sold Microsoft shares just to “rebalance” our portfolio investment areas, then we would have missed out on that growth. Selling Microsoft would have been like pruning the flowers to water the weeds. It didn’t make sense to sell it merely because the value had gone up, just to turn around and invest the proceeds in an underperforming asset.
Investing for the long term means holding your winners and letting them compound.
How CSH Can Help… Reach Out to Us!
If you are an existing CSH client and have any questions or concerns about your investment allocations, we are always here to speak with you.
If you’re not a CSH client but are unsure about the current advice you’re receiving to rebalance your investments, please give us a call at 217-824-4211. We would be more than happy to speak to you about your current situation and analyze ways it could be better.
We are a fiduciary, and this means we always act with your best interests in mind!