Portfolio Rebalancing Revisited - Adviser Investments

Portfolio Rebalancing Revisited

January 22, 2020

In this issue:

Register for Our Quarterly Webinar Today!

Registration is now open for Adviser Investments’ First-Quarter Webinar, 2020 Conflicts: Impeachment, Tariffs & Global Dysfunction, to be held Thursday, January 23 at 4:30 p.m. (EST). Sign up here!

This is a great chance to listen to and ask questions of our investment team during an in-depth, wide-ranging conversation that will cover our current thinking on the economic and market environments. You’ll hear from Chairman Dan Wiener and Director of Research Jeff DeMaso, and have your questions answered by Chief Investment Officer Jim Lowell as well as other members of our investment team. We look forward to having you join us.

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Fidelity’s Bond Queen Abdicates

Nancy Prior, Fidelity’s top fixed-income executive, will retire this year after more than six years overseeing the fund giant’s $1-trillion-plus of fixed-income assets.  Prior has been with Fidelity for 18 years and was promoted to her current role in 2014.

Assets under management at Prior’s group, which includes bond and money market funds, had grown from $714 billion under her leadership. Prior, who joined Boston-based Fidelity from the law firm Mintz Levin, was managing director of credit research before taking over the money markets group in 2011. Fidelity has yet to name her successor.

Steve Neff, head of asset management for the firm, also recently announced he would be stepping down. Bart Grenier was named as his replacement.

Adviser Investments Chief Investment Officer Jim Lowell had praise for Prior’s tenure as head of Fidelity’s fixed-income group, telling Bloomberg that she delivered on growth. Nevertheless, we don’t see her departure as cause for concern for shareholders in any of Fidelity’s bond or money market funds.

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Announcing Special Episodes of The Adviser You Can Talk To Podcast

2020 has barely begun, but it’s already brought us a plethora of portfolio-impacting news. This week, we’re bringing you two special episodes of The Adviser You Can Talk To Podcast to help you stay on top of what the latest developments mean for you.

Click the links below to listen today—it’s never too soon to become a more informed investor.

Retirement Savings Rules Have Changed: Unpacking the SECURE Act

The SECURE Act—the most significant regulatory development for retirement savers in more than a decade—contains a wide range of provisions that may apply to your bottom line.

Iran Impacts: How Middle East Tension Affects Markets

Chief Investment Officer Jim Lowell and Deputy Director of Research Brian Mackey dig through the data and sift through the sands of historical crises in the Middle East and their effects on the markets.

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Portfolio Rebalancing Revisited

Many investors use a new year as a cue to rebalance their portfolio. But is regular rebalancing really necessary?

Perhaps not, judging simply by its impact on returns. We’ve previously analyzed two rebalancing strategies recommended by Fidelity and Vanguard, time-dependent and portfolio drift, finding there was little difference in returns for portfolios following either strategy—or those that were never rebalanced at all.

But simply improving returns isn’t the only reason to rebalance. Managing risk is another important consideration, and it’s worth reviewing rebalancing’s role in risk reduction as well as the taxes, trading fees and other costs incurred by the rebalancing strategies we analyzed.

Managing Risk

Prominent advocates of rebalancing (fund companies like Vanguard and Fidelity among them) often argue that by sticking to a strictly defined allocation between stocks and bonds, you can manage the overall risk or volatility of your portfolio continuously through market cycles.

Statistically, this is true. A portfolio that’s regularly rebalanced typically exhibits lower volatility. This results in better risk-adjusted returns over time, even if total returns closely resemble a never-rebalanced portfolio. But investors need to determine for themselves how much that risk control is worth to them—it comes at a price.

Trading Isn’t Free

Perhaps the biggest negative about becoming a rebalancing disciple? Cost. Transaction fees or realized gains from trades incurred when rebalancing may take a significant bite out of your returns, especially if you’re trading in taxable accounts.

Any time you rebalance a portfolio, you should carefully review how the various transactions you’ll make will impact your tax return on top of any fees you might incur.

Ask yourself:

  • Do funds in your portfolio have front- or back-end loads or short-term trading fees?
  • Does the fund you’re buying make regular distributions? (Some funds pay annually; others quarterly or monthly.)
  • Will selling your shares of a fund create a taxable gain? (This is not an issue in tax-deferred accounts like IRAs and 401(k)s.)

Thinking through these questions may help you realize how quickly the hidden costs of rebalancing can suck the wind out of your portfolio’s sails.

You may be able to mitigate the tax impact of rebalancing by adopting a more flexible approach to rebalancing. Instead of trading on a fixed schedule or when allocations pass a given threshold, you could direct any distributions or new investments into the under-allocated funds in your portfolio. Or if you’re using the portfolio for income, you could sell more of your winners’ shares to reduce their allocation. (This will create its own tax liability, but you can’t avoid taxes forever if you’re drawing down your portfolio.) These techniques can help keep taxes and expenses down, unlike making numerous trades over the course of a year.

Keeping a Level Head

Something not to be overlooked when considering rebalancing: You’re only human. If you have a fund in your portfolio that’s been outperforming month after month, you’re probably not going to be in a rush to sell it to invest more in a fund that’s lost you money. But the central theory underpinning rebalancing requires you to do just that. Not just once. Over and over again. As Vanguard founder Jack Bogle once put it: “If you are going to rebalance, you have to be absolutely clinical, or you are better off not doing it.”

You could, of course, take the more relaxed approach and rarely rebalance—if at all—as long as you can stomach the increased volatility that is part of an “unbalanced” portfolio. Indeed, when you consider the bill from Uncle Sam that results from frequent trades, you could come out substantially ahead. As our analysis shows, when it comes to returns, going with the flow can be a good idea. That’s why Adviser Investments’ investing philosophy is to make strategic trades when opportunities present themselves, rather than engage in regular or systematic trades (unless it’s something specifically requested by a client to meet their financial or investment needs, of course).

Some final considerations, if you do choose to rebalance:

Review Allocations. Before you rebalance, review your target allocations. Do you still have the same investment goals? Has your risk comfort zone changed? As the years pass, your initial allocation may no longer be a good fit. Make sure when rebalancing that the mix of stocks, bonds and cash in your portfolio matches your current and future needs.

Doublecheck Paperwork. Making multiple trades per year comes with some hassles. Even if you’re making your trades online, make sure to review your statements and track every change to make sure there weren’t any errors (on your part or the fund company’s).

Check In Regularly. If you’re following a portfolio-drift scheme, you’ll need to stay on top of your portfolio to trade at the right times.

So is rebalancing necessary? Despite what the financial press or your favorite fund company may claim, when you examine the evidence there is little benefit to returns, and only modest benefit to risk exposure. (Again, that’s assuming no tax consequences or trading fees.)

That said, if rebalancing regularly provides peace of mind and you’re willing to be clinical about it, your portfolio may not suffer too much for it.

About Adviser Investments

Adviser Investments operates as an independent, professional wealth management firm with expertise in Fidelity and Vanguard funds, actively managed mutual funds, ETFs, fixed-income investing, tactical strategies and financial planning. Our investment professionals focus on helping individual investors, trusts, foundations and institutions meet their investment goals. Our minimum account size is $350,000. For the seventh consecutive year, Adviser Investments was named to Barron’s list of the top 100 independent financial advisers nationwide and its list of the top advisory firms in Massachusetts in 2019. We have also been recognized on the Financial Times 300 Top Registered Investment Advisers list in 2014, 2015, 2016, 2018 and 2019.

For more information, please visit www.adviserinvestments.com or call 800-492-6868.


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