If you ask me, rebalancing has to be one of the Wonders of the World. Ok, well maybe at least one of the Wonders of the Investing World. The term “rebalancing” (or “optimizing” as we call it at blooom) gets loosely tossed around and often even taken for granted, but I hope to explain its elegance and how rebalancing investments can go such a long way to improving an investor’s long term rate of return. More specifically, by leveraging the power of optimizing, especially in down markets, it is entirely possible to build more wealth in your investment portfolio over time.
Now that I have your attention, let’s look under the hood at how this whole optimizing thing really works!
Take Emotion Out of It
By far, one of the biggest enemies of the average individual investor is their own emotions. Generally speaking, mixing high levels of emotions into financial decision making will generally turn out disastrous, regardless of how good the underlying intentions might have been. Emotions will lead us astray whether it is greed commonly experienced in periods of very strong growth in the stock market, or fear often experienced in periods of steep declines in the stock market.
The most effective way to counter the potential damage that managing your investments based on emotion can cause, is to just simply have a plan. Then, once you have a plan, to the extent possible, you should try to implement a strategy that “automates” decision making so that you minimize the chances that emotions can creep into your decision making. In fact, some of the best laid plans when it comes to investing are ones in which you have to make as few decisions as possible!
Let me explain.
3 Things You Should Do With Your Investments Right Now
When it comes to your retirement savings – either inside of your employer sponsored retirement account (401k, 403b) or your IRA – you need to commit to a well thought out strategy that has been battle tested not over the course of just the past few years, but over the past many decades. When it comes to your retirement savings, because of the inherent long term time horizon that you should have, there are really just a few key things to get right.
- Make sure you have an appropriate mix of stocks and bonds given your time horizon to retirement and your risk tolerance. With this, there is no “one right answer” but it is definitely possible to get this dead wrong. (Example: 30 year old who wants to retire at age 60 with 90% invested in bonds)
- Make sure this mix of stocks and bonds is routinely adjusted to move slightly more conservative as you move closer and closer to retirement.
- Make sure you have enough diversification across your stock and bond exposure. In other words, make sure you don’t have “too many eggs in too few baskets!”
Then, Don’t Touch It
Once you have this established, I can tell you confidently that you shouldn’t be tinkering too much with this set up. In other words – get this dialed in and there is virtually no need to be fiddling with it based on the inevitable ups and downs of the stock market. This is where investment rebalancing comes in and starts to really shine.
An Example Portfolio
For ease of explanation, let’s assume that based on your age, time horizon to retirement and risk tolerance, you have the following allocation in your retirement account:
Stocks: 70% Target allocation = $70,000
Bonds: 30% Target allocation = $30,000
Now let’s assume that the stock market gets absolutely clobbered, down roughly 30%. Which by the way, is about the average decline the stock market has experienced in the past dozen or so Bear Markets since WWII. Remember, Bear Markets are a totally normal and expected event that inevitably comes around from time to time either due to economic cycles, bubbles, or significant external events like what we are currently experiencing with the global pandemic.
In our example here, let’s also assume that while stocks were getting clobbered, the bond side of your portfolio largely held its value. In this case, your allocation could then look like this:
Stocks: $50,000 – 62.5%
Bonds: $30,000 = 37.5%
Often times, investors are inclined to make emotional decisions out of fear (in this case) and might actually consider SELLING OUT of stocks after this big decline. BUT, this is where optimizing can swoop in and save the day.
If you are following a regular, recurring strategy of rebalancing your investments let me show you INSTEAD what would take place
Now that your portfolio has dropped in value to $80,000 and stocks now make up just 62.5% of the portfolio as opposed to the original target allocation of 70% that you originally established. To then properly rebalance your account back to the original Target allocation into stocks you would need to SELL some of your bonds that had held their ground and BUY more stocks at these depressed levels. PRECISELY WHAT INVESTORS SHOULD BE DOING! It is amazing how in times where the stock market is chugging along making new highs, most investors jubilantly pour more and more money into their portfolios and then conversely, when the stock market goes “on sale” many investors’ emotions kick in and then all rational thought goes flying out the window and fear takes over.
But when you allow the power of an automated optimizing strategy to just do its thing, it prevents emotions from creeping in and taking over. You are not having to make decisions at all during these times. The automated optimizing process handles all the heavy lifting and by just doing math, it automates the process of proper decision making over and over and over, throughout the course of your investing career.
Oh, and conversely – an automated optimizing strategy also works quite well in times of growth in the stock market. As stocks and the stock market are making new highs, automated optimizing will trim some of the profits in stocks and add to bonds, or other kinds of stocks in your portfolio that have fallen a bit behind. Again, just letting mathematics handle the decision making process in your portfolio.
See “Buy Low, Sell High” in Practice
What I love most about utilizing an automated optimizing strategy is that by default, it forces investors to follow that age-old practice of buying low and selling high. Slowly and surely, over time, portions of your retirement portfolio are shifted from the investments or asset classes that have performed well over to the investments or asset classes that haven’t done as well. Little by little over a long period of time this adds up to extra return in your account and most importantly, gets you out of your own way when it comes to emotional decision making.
Reap the Benefits of Rebalancing Your Investments with Blooom
Now that you have read why rebalancing your investments is important, consider optimizing your portfolio with blooom! Our goal is to give you a solid chance to improve the allocation of your account and maximize your portfolio. Sign up today for a free analysis and see how rebalancing your investments with blooom is a no brainer!
Published on May 11, 2020