Home Adviser Fund Update Portfolio Rebalancing Revisited Published January 22, 2020 Table of Contents Register for Our Quarterly Webinar Today! Fidelity’s Bond Queen Abdicates Announcing Special Episodes of The Adviser You Can Talk To Podcast Portfolio Rebalancing Revisited 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. If you’re unable to make it to the live event, you can watch the on-demand replay (and pose a question for the team) by clicking here. * * * Fidelity’s BondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. 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 bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. 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. * * * 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. * * * 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 riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. 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 RiskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. Prominent advocates of rebalancing (fund companies like Vanguard and Fidelity among them) often argue that by sticking to a strictly defined allocation between stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. and bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates., you can manage the overall risk or volatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in. 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 liabilityLiabilities are calculated by adding up your existing debts (mortgage, car loans, student loans, credit cards, etc.)., 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 is a full service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trustsA legal document that functions as an instruction manual to how you want your money managed and spent in your later years as well as how your assets should be distributed after your death. Assets placed in a trust are generally safe from creditors and can be sold by the trustee in short order, avoiding the lengthy and costly probate process., institutions and foundations since 1994, and have more than 3,500 clients across the country and over $6 billion in assets under management. Our portfolios encompass actively managed funds, ETFsA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index., socially responsible investments and tactical asset allocation strategies, with particular expertise in Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. Our minimum account size is $350,000. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868. 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