You wouldn’t set sail on a cross-Atlantic journey without occasionally checking your course. Investing is no different. To reach your financial destination, regular review and rebalancing of your portfolio are essential. This post will delve into the mechanics of reviewing your investments, the opportune moments to rebalance, and the undeniable benefits of maintaining a proactive stance.
The Case for Regular Reviews
Imagine you’re running a high-performance racing team. Your car, meticulously designed and finely tuned, races around the track. Yet, without periodic pit stops to check tire pressure, fuel levels, and engine health, even the best car can falter. Your investment portfolio, whether a sleek stock-heavy machine or a conservative bond-laden vehicle, requires similar attention.
Staying Aligned with Your Goals
Your financial goals are your North Star. Whether saving for a house, funding your child’s education, or preparing for retirement, these goals shape your investment strategy. But life, like the markets, is dynamic. Goals evolve, timelines shift, and risk tolerance changes. Regular reviews ensure your portfolio remains aligned with these evolving targets.
Life Changes and Their Impact
Imagine someone who is single and early in their career invested heavily in growth stocks aiming for aggressive capital appreciation. Marriage, a child, and a new mortgage later, their risk tolerance and investment horizon shifted significantly. Regular reviews will help you pivot your strategy, incorporating more stable, income-generating assets like bonds and dividend-paying stocks.
Monitoring Performance
Performance review is not just about returns; it’s about understanding why your portfolio performs the way it does. Are your assets appreciating due to market trends, or is it your asset allocation strategy paying off? Conversely, if your investments are underperforming, a review helps identify the culprits, be it market conditions or perhaps a fundamental flaw in your strategy.
The Role of Market Conditions
Markets are volatile and cyclical. Bull markets can make even the most cautious investor seem like a genius, while bear markets can humble the boldest. Regular reviews allow you to understand how market conditions impact your portfolio, helping you make informed decisions rather than reactive ones.
The Mechanics of Review
Reviewing your investments involves more than just a cursory glance at your portfolio's value. It requires a structured approach to evaluate your asset allocation, individual asset performance, and overall strategy.
Asset Allocation Check
Your initial asset allocation was likely designed based on your goals and risk tolerance. Over time, market movements can distort this balance. For instance, a surge in stock prices might leave your portfolio overexposed to equities, increasing your risk.
Practical Steps
- Assess Current Allocation: Compare your current asset allocation with your target allocation.
- Analyze Deviations: Identify significant deviations and understand their causes.
- Determine Adjustments: Decide if adjustments are needed to realign with your target allocation.
Individual Asset Performance
Not all investments perform uniformly. Some stocks may soar, while others stagnate or decline. Bonds might provide steady income, but their prices fluctuate with interest rates. Regularly assessing the performance of individual assets helps identify underperformers that may need to be replaced and outperformers that might require profit-taking.
Key Metrics
Key metrics are specific, quantifiable measures that you can use to evaluate the performance, efficiency, and success of different aspects of your portfolio. i.e. If you can only pay attention to three things, what are the three most important things that when looked at together will give you a full understanding of the whole. These metrics provide critical insights that help in making informed decisions, setting goals, and tracking progress.
Purpose of Key Metrics
- Performance Evaluation: Key metrics help in assessing how well a company or investment is performing.
- Goal Setting: They provide benchmarks for setting and measuring progress toward SMART objectives.
- Decision Making: Metrics offer data-driven insights that inform strategic and operational decisions.
- Transparency and Accountability: They ensure that all stakeholders have a clear understanding of performance and areas for improvement.
The Key Metrics that you want to look at in each portfolio review:
- Total Return: The overall gain or loss of an investment over a specific period.
- Volatility: The degree of variation in an asset's price over time, indicating its risk.
- Risk-Adjusted Return: Measures how much return an investment has provided relative to the risk taken. In Part Four we’ll delve into the Sharpe ratio which is often ised to calculate this, but essentially you are just reviewing ‘Did I make as much as I should have made for taking the risk that I took?’
Strategy Evaluation
Your investment strategy should be dynamic, adapting to new information, changes in your personal circumstances, and shifts in market conditions. Your initial strategy is not a set it and forget one. Regular reviews help assess whether your current strategy remains viable or requires tweaks.
Questions to Ask
- Are my investments still aligned with my goals?
- Has my risk tolerance changed?
- Do market conditions warrant a strategy shift?
When to Rebalance
Rebalancing is the act of realigning your portfolio to maintain your desired asset allocation. This ensures that your portfolio remains in line with your risk tolerance and investment goals, despite market fluctuations.
Scheduled Rebalancing
Scheduled rebalancing involves adjusting your portfolio at regular intervals, such as quarterly or annually. This disciplined approach prevents emotional decision-making and keeps your portfolio aligned with your strategy.
Benefits
- Simplicity: Rebalancing on a set schedule is straightforward.
- Discipline: Removes the emotional element from investment decisions.
The Benefits of Staying Proactive
Risk Management
Regular reviews and rebalancing help manage risk by maintaining your desired asset allocation. By preventing overexposure to any one asset class, you mitigate the impact of market volatility on your portfolio.
Enhanced Returns
While rebalancing might seem counterintuitive – selling high-performing assets to buy underperformers – it enforces a buy-low, sell-high discipline that can enhance long-term returns.
Avoiding Emotional Decisions
Markets are driven by emotion as much as by fundamentals. Fear and greed can lead to poor investment decisions. A disciplined approach to reviewing and rebalancing helps avoid emotional reactions to market swings.
Keeping Costs in Check
Rebalancing can incur transaction costs, but these are often outweighed by the benefits of maintaining a balanced portfolio. Regular reviews also help identify high-fee investments that may need to be replaced with more cost-effective alternatives.
The Process of Rebalancing
Write Down Your Strategy
Based on the investment strategies dicussed in chapter six, write down your target allocation
i.e. Ray Dalio’s All Weather Portfolio
- 30% Stocks: Provides growth potential during economic expansions.
- 40% Long-term Bonds: Offers stability and income during deflationary periods.
- 15% Intermediate-term Bonds: Balances risk and return with moderate duration.
- 7.5% Commodities: Acts as a hedge against inflation and economic uncertainty.
- 7.5% Gold: Serves as a store of value and hedge against currency devaluation and inflation.
Executing the Rebalance
When it’s time to rebalance, follow a systematic approach:
- Identify Deviations: Determine which asset classes have deviated from your target allocation.
- Calculate Adjustments: Calculate how much of each asset class to buy or sell to realign your portfolio.
- Execute Trades: Place the necessary trades to bring your portfolio back in line with your target allocation.
Considering Tax Implications
Rebalancing can trigger taxable events, especially in non-tax-advantaged accounts. Consider tax-efficient strategies, such as using tax-loss harvesting to offset gains or rebalancing within tax-advantaged accounts.
Real-Life Examples of Rebalancing
The Tale of Two Investors
Investor A: The Disciplined Rebalancer
Investor A reviews and rebalances his portfolio quarterly. Over the years, he has consistently maintained his target allocation, weathering market downturns with less volatility and capturing gains during upswings. His disciplined approach has resulted in steady growth and reduced risk.
Investor B: The Passive Ignorer
Investor B, on the other hand, set up his portfolio and left it untouched for years. Initially aggressive, his portfolio became overly concentrated in tech stocks during a bull market. When the tech bubble burst, he suffered significant losses, eroding much of his gains. His passive approach exposed him to unnecessary risk and volatility.
The Benefits in Numbers
Consider a hypothetical portfolio with an initial allocation of 60% equities and 40% bonds. Over a five-year period, equities outperform bonds, resulting in a 75% equity and 25% bond allocation. Rebalancing annually back to the 60/40 allocation would have locked in gains from equities and reinvested in bonds, potentially enhancing overall returns and reducing risk.
Regularly reviewing and rebalancing your portfolio is not just a good habit – it’s a crucial strategy for long-term investment success. By staying proactive, you ensure that your investments remain aligned with your goals and risk tolerance, navigate market volatility with greater confidence, and ultimately achieve your financial objectives.
In the ever-changing world of investing, maintaining a disciplined approach to review and rebalancing is your safeguard against the whims of the market. It keeps you focused, reduces emotional decision-making, and optimizes your portfolio's performance. As you continue your journey as your own financial investment manager, remember that the path to financial success is not a sprint but a marathon. Regular review and rebalancing are the steady, guiding hands that will keep you on course, no matter what the markets throw your way.
Take Action
Make a date with yourself in your calendar every three months for review and rebalancing.
Empower Your Wealth: Become Your Own Financial Investment Manager is a 20 part series that teaches readers how to self-manage their investments. It covers basics to advanced strategies, emphasizing the importance of financial independence, diversification, risk management, and technology