Written By: Jamie Stolz, CFP® My son is 3 years old—an age that can be one giant test of patience for any parent. At the moment, my biggest parenting challenge is grocery shopping. Why? My son is absolutely obsessed with pushing the grocery cart through the store… without my help. For a child who can barely reach the cart handle, this can make shopping adventurous at best, and, at worst, downright dangerous if Mom isn’t paying attention!Of course, when he does veer off course, it’s my job to gently but firmly steer him back on track to avoid any unfortunate mishaps. If I don’t, the store displays—and my fellow shoppers, too—could be in serious peril!As a portfolio manager, I can’t help but see the parallel between my constant quest to keep my grocery cart moving slowly and steadily in the right direction and keeping our clients’ portfolios aligned with their goals. In both cases, my role is to get the trajectory back on track when things get a little too far from a safe “baseline” by “steering” things in the right direction.Of course, the process of steering portfolios is much more critical than navigating grocery carts. Even if my son managed to knock down a store display of paper towels (please, help me!), the impact would be short term. With a little assistance and patience, we could clean up the mess and be back on track within the hour. When it comes to investing, however, the potential impact of being even a little off course is much greater—which makes this process of steering critical to your long-term success.As every investor knows, the purpose of creating a diversified portfolio is to own a variety of asset classes that are likely to perform in opposition to each other during normal market conditions. When stocks rise, bonds typically fall, and vice versa. That juxtaposition is true for other asset classes as well. By crafting a portfolio that includes a strategic mix of these various classes, you can help protect your portfolio against market downturns, while also positioning it for steady growth over the long term.But just building a well-balanced portfolio isn’t enough. Unfortunately, it’s all too easy to forget that what was once an ideal asset allocation can fall out of balance as the market shifts—or as your finances, goals, or retirement plans change over time. When that does happen, the best way to stay on track is to steer your portfolio back on track , always with an eye to your long-term financial goals. In the investment world, this is called “rebalancing.”
What is rebalancing, exactly?
When the market shifts, the percentages of different asset classes in your portfolio change. Often, that change can push them out of line with your target investment objective. Correcting that alignment requires “rebalancing” the portfolio, which entails selling off a portion of those asset classes that have outperformed, and buying asset classes that have underperformed.At TandemGrowth, we monitor each client’s portfolio on an ongoing basis, rebalancing as needed to be sure each asset class is within its target allocation range, and replenishing each short-term portfolio annually. With every action we take, we always keep tax consequences in top of mind, continually looking for losses throughout the year. Here’s how the process works:
We place specific thresholds around each asset class. If the percentage we’ve allocated for a certain asset class shifts outside a certain percentage of its threshold, we rebalance the portfolio to align it with the target. By taking action only after asset classes hit the threshold—not whenever they are just slightly off target—we allow them to gain some momentum in either direction, positive or negative, before rebalancing occurs. This method helps us avoid selling a high-performing asset class too soon, or buying a falling asset class too early. We use rebalancing software that analyzes every portfolio daily. While we certainly don’t act on the results of the analysis every day, as the Portfolio Manager, it’s my job to review the results and determine if trades need to be made. Rebalancing is often recommended when asset classes are outside of their threshold or when there are securities with unrealized losses that we can sell to offset gains. We trim asset classes that have outperformed and add to those that have underperformed. This is especially important in volatile markets because it forces us to buy low and sell high without letting emotions get in the way. For many investors, rebalancing when the market is doing well is emotionally challenging. After all, who doesn’t want to take advantage of a great market run? But letting the equity portion of your portfolio ride is risky. That strategy makes it all too easy for an asset class to get pushed into a higher allocation than you’re comfortable with, and create losses that are highly uncomfortable—especially if the market drops 20% or more. We focus on tax-loss harvesting. Selling high is optimal, but it can also mean realizing costly gains in taxable accounts. To minimize taxable gains, we begin by trying to sell within tax-deferred accounts like an IRA. If that’s not possible, we look for opportunities throughout the year to practice tax-loss harvesting by selling a fund you own that has lost value and buying an ETF (exchange traded fund) in its place. This strategy can help minimize the taxes you pay on sizable gains to help protect and grow your assets more efficiently. We use a short-term portfolio to provide a buffer against market volatility. Including a short-term portfolio in your strategy is another way to protect your assets for long-term growth. If you are retired, the last thing you want to do is to be forced to sell securities during a market downturn to meet your cash flow needs. Your short-term portfolio is typically invested in cash or other “safer” asset classes that present less risk of volatility, giving you the freedom to wait for the market to turn positive again without having to sell low.Related:
The Truth About Unicorns and “Buying What You Know”As an investor, your goal is to keep your portfolio on a slow and steady course from start to finish. Think of your portfolio like a grocery cart full of precious resources for the future. When the market does something that causes your cart to veer a little too close to that towering display of paper towels (!), it’s time to rebalance, realign, and get back on track. That little bit of “steering” is the best thing you can do to keep your level of risk in line with
your current financial objectives, capture sporadic opportunities to buy-low and sell-high throughout the year, and use tax-saving opportunities to outweigh the costs of trading. As always, we’re here to help!
