95 – Rebalancing


Episode Overview:

Ken discusses the value of rebalancing your portfolio on a regular, fixed schedule. This device is not meant for “gaming” or timing the market, but rather to correct your risk/return parameters. If funds over or under perform, your holdings may no longer reflect your goals. For example, if your riskier holdings outperform projections, your portfolio is over-weighted with riskier assets. Ken walks you through the timing and tactics of a rebalance – including yearly cash injections or shuffling of holdings.

Transcriptions are auto-generated, please excuse grammar/spelling!

Happy day to you. This is Ken Kaufman, and I’m thrilled you’re here for Episode Number 95, how to rebalance your investment portfolio. This is something that maybe we don’t think about that often where we’re investing money away, and we just leave it away, and we don’t pay attention to it. I want to be clear that it can make a lot of sense at some regular interval, not based on market timing or when you think the market is going to go up or down, but on a set predetermined calculated schedule going through and doing a rebalance of your investments. And there’s a couple of different ways to go through it. Let me start by talking about the win. So, most of the research shows that annually is adequate. Sometimes you can pick up a little benefit when you do it monthly in some of the research that I’ve seen but for me, I do it annually and to remember I put it on my wife’s birthday. That’s the day, it’s in the summertime, when I rebalance all of the investments. And I think by picking a specific interval, and not making it about the market, it makes it very, very easy because what happens, and the reason why you’d want to rebalance is and what would cause it is, you would have some investments that would be doing better, meaning they’re growing more and out of proportion with the percentage that you wanted them to be the overall portfolio to others that are doing worse. You know, maybe one’s performing at a really high-level return, the other is at a medium level of return. Or maybe one’s gone up and one’s gone down. Regardless of what it is, you want to give the ones that are doing well some time to run up and get hopefully benefit out of it, but you can’t plan on that forever. And ultimately, if you have a very clear strategy, and in essence, an investment policy that says here’s the percentages that I want in my investment and this is what’s going to bring me based on numbers, and risk profiles, and things the most amount of potential return relative to the risk that you’re taking, or the level of volatility that you’re exposing yourself to and the investment portfolio that you’ve built, it gives you the best opportunity if you stay within the parameters of the percentages of the portfolio that the different investments make up.

So, let’s say you have two investments, and we’ll go with the two funds for life strategy that Paul Merriman and Richard Buck have written about and talked a great deal about. I highly recommend their work. They recommend that throughout a person’s life two funds for life is all you would need because you could put some money into the retirement date fund, and the rest of the money into a small-cap value fund. So, it gives you access to a well-diversified portfolio in the retirement date fund, but where it might be conservative in terms of having bonds in at a too early of an age, or where it perhaps doesn’t have enough exposure to the value and the small category where there can be some really nice growth opportunities, it basically takes these two funds and puts them together. And let’s suppose that you have $1,000 in each of them to start, and after a year one has done really well and one has done poorly. So, for example, one’s gone up to $1,500 and the others dropped to $500. So, again, your overall balance hasn’t changed, but one ran up and one slid dramatically. The concept here would be to return them back to the $1,000 and the $1,000 as long as that’s what your investment policy is, by selling the one and buying the other and evening it back out again. It makes sense to do this over time but monthly or, you know, daily those types of time intervals can cut off where some of the potential gains are if you just kind of let it take its run or take its course at least for some period of time. So, the methodology that you should be thinking about when you do this is first, is there going to be a tax consequence when you rebalance. If you’re in a taxable portfolio, which means it’s not in a retirement fund or something that grows tax-deferred where you don’t have to pay capital gains tax for selling investments and those sorts of things, that’s not what I’m talking about. A taxable account is where you have to pay taxes when you sell investments. The absolute best way to rebalance in your taxable portfolio is to put more money in. So, in the example of the $1,500 where the investments were $1000 and $1,000, and one went up to $1,500 and the other went up to or dropped to $500, the best strategy there would be to put another $1,000 into the one that dropped to $500 so that now you have a balance of $1,500 and $1,500 and you’re a 50/50 split again. That is the ideal.

Now, we don’t always have enough money to go in and makeup and buy in to bring the portfolio into balance which by the way, there’s an interesting point here. When you do this rebalance what’s happening is, you’re buying at the lower prices, because it means some of those asset classes have fallen out of favor or not done well, and so you have lower pricing. So, it’s a beautiful strategy that takes out market timing and takes out emotion and really automates you continuing to invest probably where prices are going to be the most attractive. Now, when in that taxable portfolio, that’s the best way. The next best way is to take a close look and see what assets have capital gains potentially built up in them, how that might impact your taxes, and to think that through and plan and strategize through that before you sell some investments and then buy the others. In a, I guess I’d call it non-taxable or it’d be like a retirement account where you have deferred taxes and you don’t have to pay them on any transactions in the portfolio, then it’s very easy to go ahead and sell the stuff that’s gone high, and put it into the stuff that’s gone lower, and get your portfolio back into balance. And there are a couple ways to do this. There are some services that will do this for you. You can hire people to do it, you can whip out a spreadsheet and throw in your investments. But the key point is to understand these are the percentages of the overall portfolio that I want each of my assets to be at and then, you are selling and buying to get it back into the proper weighting in each of your different investments or asset classes that you’re invested in. So, a spreadsheet is a very simple way to do it. You can execute the trades and it’s all good to go. I’ve told you guys before, I use M1 Finance and with the pies that you build in there, I can just go in and hit rebalance on my wife’s birthday, and it just rebalances, and it’s done. Some 401K plans are pretty great about this where you can pick your investments that you want and then you can ask it to do a rebalance, and you can set the timing of it. And so, it’s pretty cool. The 401K plan, I literally just said, put my wife’s birthday in and said what I wanted to happen when the rebalance occurred and it’s just going to happen automatically, and don’t have to worry about taxes because of the account that it’s in. HSA account, same don’t have to worry about the cost of any taxes because it’s all within that tax-deferred account.

So, that’s basically it. It’s pretty simple process. I recommend annually for most people, but I don’t know your situation. I should say I recommend it for myself. I don’t know what your situation is. It’s what I’m comfortable with. Pick your interval, pick a specific date of the year when you do it. Don’t be subject to market timing, or the news, or acting to rebalance based on anything other than pick a nice date that you consistently do it on, and do it without fail and then pick one of these strategies, whether you’re putting more money in to get it rebalanced, or you’re deciding to sell investments and, you know, watch out for that taxable portfolio. If you do that, make sure that you’re thinking through tax consequences. And then you have one day where everything’s perfectly in balance and then it all starts to slip out of balance again because investments are investments and they’re going to go up and they’re going to go down. And hopefully, you have some that are going up while they’re going down. That’s hopefully by having multiple asset classes you’re getting that level of diversification and leveling out some of those returns over time. So, hope this has been helpful. Many, many thanks to you for joining today. This is a wrap for Episode 95. Happy day.

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Join Chief Financial Officer Ken Kaufman as he helps you track and hack your net worth. For those seeking financial independence, your net worth is one of the most significant measurements of success. Using his two decades of financial experience, Ken Kaufman helps you overcome your financial obstacles and look onward towards a better, brighter financial future.


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