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Rebalancing to Optimize Wealth Preservation
Posted in Wealth Management Solutions | Mar 2011 | Comments (0)
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What is rebalancing and why do it?
Rebalancing is not about timing the market and changing your portfolio every time the new and hottest investment topic comes up at a cocktail party or in the operating room. Simply stated, rebalancing is the process of realigning the proportions of assets in a portfolio. The market is always in motion, hence natural evolution dictates that investments will rise and decline, some more than others. As a result of this occurrence, the balance or weight of the asset classes will change. Hence the term “rebalancing” or reverting back to the percentage you originally allocated.
Rebalancing then serves two important functions: First, to keep the portfolio level of risk consistent with your tolerance for risk and second, to help manage the return based on your expectations. Research supports this theory. In his paper, Dr. Gobind Daryanani CFP®, Ph.D. offers empirical analysis that rebalancing regularly improves the total return of portfolios compared to irregular rebalancing. (Opportunistic Rebalancing: A New Paradigm for Wealth Managers, Journal of Financial Planning, January 2008)
During the recent recession, many investors also discovered that not rebalancing and not being properly diversified cost them dearly. Lack of liquidity coupled with an increase in risk caused investors to lose principal. Of course, rebalancing incurs trading and tax costs; however, it is our belief that the benefits of rebalancing far outweigh the costs.
What is the optimum time to rebalance my investment portfolio?
Rebalancing is essential to every investor and maintains the target allocation in your investment strategy. There is not one single answer as to how often to rebalance a portfolio. The proverbial “it depends” is absolutely in play here. First, what is the portfolio objective, the current asset mix within that portfolio and your timeline and risk threshold? Next, what are your cash flow requirements, liquidity needs and desire for tax efficiency?
At the heart of portfolio construction is asset allocation: a strategic mix of assets and their respective asset classes—Equity (domestic/international, developed/emerging/frontier, value/growth, large cap/small cap); Fixed Income (domestic/international, sovereign/corporate, short/long); Real Estate (public/private, loans/properties); Commodities (public/private, energy/crops/metals), Private Equity (domestic/international) and Cash or Cash Equivalents. Each specific asset class and investment is tied to the risk of loss and the potential for gain and appropriately balancing to get to a risk and a return level that will make you happy.