Portfolio Diversification: The Key to a Happy New Year

By Chris Duderstadt

December 27, 2021

Portfolio Diversification: The Key to a Happy New Year

Key Points – Portfolio Diversification: The Key to a Happy New Year

  • Your Ideal Portfolio Diversification Won’t Be the Same as a Couple of Years Ago
  • Why You Should Revisit Rebalancing to Begin the New Year
  • Finding Portfolio Diversification on a Rebalancing Rollercoaster
  • Why Holding on to Too Much Equity Can Be Excruciating in the Long Run
  • Tackling the Option of Target Date Funds
  • 6 minutes to read

As you make your New Year’s financial resolutions, remember that risk will always be guaranteed within the markets. However, proper portfolio diversification can go a long way toward reducing that risk. Modern Wealth Management CEO and Founder Dean Barber and Director of Financial Planning Jason Newcomer discuss why it’s important to assess that risk by rebalancing as 2021 comes to a close.

Your Ideal Portfolio Diversification Won’t Be the Same as a Couple of Years Ago

Controlling your risk can be much easier said than done. Nevertheless, ideal portfolio diversification isn’t that hard to achieve if you’re actively rebalancing. Whether you’re rebalancing annually, semi-annually, or quarterly, all are better options than doing nothing.

Dean shares that the biggest thing people need to think about when rebalancing is that your portfolio diversification should be different than what it was a couple of years ago.

“Let’s say somebody has increased the value of their overall portfolio by 40% over the last two years. With that much more money in your overall portfolio, the amount of money that you need in equities to drive the return that you need now for your plan to work may be totally different,” Dean said. “You may have needed a 70-30 portfolio two years ago. But today, you can go down to a 40-60. You may have been 60-40 before and now you can go down to 50-50.”

Why You Should Revisit Rebalancing to Begin the New Year

Now, with the amount of money that you have, use the financial plan to ask what the least amount of risk is that you need to take to accomplish what you want to accomplish. We want you to begin the new year with adequate portfolio diversification, so now could be a good time to revisit rebalancing if you haven’t done so in a while.

Furthermore, what makes now a good time to rebalance? Dean pointed out in his November Monthly Economic Update that the NASDAQ 100 is up more than 25% over the past year, and the other top-performing indices aren’t far behind. Meanwhile, bonds are down about 1% over the past year.

“Let’s say you started the year as a 60-40 portfolio and your stocks have been 25% and your bonds have lost 1%. Your allocation today is closer to two thirds in stocks with the remainder in bonds,” Jason said. “Now you’re exposed to more downside risk than you were at the beginning of the year just because you’re more heavily weighted toward stocks. If you were thinking at the beginning of the year that you don’t want more exposure to the stock market than 60% and you look at your portfolio today and it’s closer to 70% than 60%.”

That being said, Jason has a few questions for you.

  1. Are you still comfortable with that?
  2. If not, do you need to be making changes to achieve your new portfolio diversification goal with rebalancing and harvesting some of those gains?

You can move that money back into a more conservative position to ensure longer-term portfolio diversification.

A Rebalancing Rollercoaster

The onset of the COVID-19 pandemic highlighted how rebalancing can truly be a rollercoaster. As Dean and Bud Kasper recently mentioned on America’s Wealth Management Show, March 2020 was a time to do some offensive rebalancing since stocks took a major hit. However, with the steady gains we’ve seen in the markets since April 2020, we’ve seen more defensive rebalancing with going into assets that aren’t doing as well and rebalancing from a risk perspective. In both situations, the ultimate goal is portfolio diversification.

“If you were starting with a portfolio last year, you were likely purchasing stocks and selling bonds in the February/March timeframe. Since March 2020, stocks have done nothing but go up except for September 2021 when the stock market fell by about 5%,” Jason said. “That’s about all we’ve seen in terms of downward movements in the stock market. If you stick to a rebalancing plan, whether it’s monthly, quarterly, semi-annually, annually, or if it’s based off how far away positions are drifting in your portfolio, you’ve likely sold shares of stock funds at least once along the way.”

An Example of Holding on to Way Too Much Equity

Let’s go back even further and review another tumultuous time in the markets with the Dot-Com Bubble. It was then when Dean experienced the craziest instance he’s had with a client holding on to too much equity.

The whole situation centered around greed. In this case, the client was impatient with the traditional portfolio diversification model. He kept insisting that more money be added to telecommunication and technology stocks, which were huge in the late 1990s.

“I vividly recall the phone conversation that I had with this gentleman in December 1999,” Dean said. “I told him he needed to focus on portfolio diversification because his portfolio was 97% technology and telecommunications stocks. He said no way because that’s where the money was. This gentleman thought he had it all figured out by holding on to what he had. Within two and a half years, he was down by more than 70% on those holdings because he refused to believe that the risk was real and that the decline could continue. Consequently, he ended up going back to work.”

Looking Long Term

Along with portfolio diversification being a key to a happy new year, it’s also critical when looking at your financial plan from an even longer-term perspective. That applies whether you’re five years or so away from retirement or already retired.

“What you’re trying to do with your investments in retirement is create a predictable source of income. When you have a year like we’ve had here in 2021, it might be a good idea to create three or four years’ worth of income from the growth in your portfolio this year,” Dean said. “Go ahead and harvest that now. Set it in a safe spot where you know that the market volatility that may come in the next few years won’t impact your ability to get the income that you need.”

Tackling the Option of Target Date Funds

Speaking of looking long term, let’s look at target date funds. They are popular because a lot of 401(k) plan providers use them as a simple solution for employees to invest in. Jason believes that target date funds are better than a lot of the Frankenstein portfolios that you see sometimes because they’re built with the goal of portfolio diversification.

“They’re built to get more conservative as you approach your retirement date,” Jason said. “For example, say you plan to retire in 2025. When you hit your retirement date, those target date funds aren’t going to be 0% in stocks. They’re built to get you to retirement and have an allocation starting in 2025 that will last you through retirement. By the time you get to 2025, that fund could still be exposed to 50% stocks. A lot of people think there’s going to be little to no risk when that retirement date fund ‘matures.’ People need to understand what it is that they own inside of those target date funds.”

Jason remembers how imperative it was for people to research of what was inside their target date fund during The Great Recession. Target date funds were under a lot of scrutiny at that time.

“Let’s say someone was getting ready to retire and had a 2010 target date fund. They lost 35% of their investment account in 2008,” Jason said. “This fund should have been preparing them to retire in 2010. Why expose it to so much risk?”

Keeping It Simple

Considering how high stakes are with retirement planning, it’s paramount to keep a simplistic approach with your research. Jason has seen some very good portfolios that only utilize two to three different funds.

“For someone who’s very simplistic, like myself, that makes a lot of sense,” Jason said. “I don’t want to spend evenings and weekends with worrying about whether my portfolio is overweight or underweight into stocks. I set up defined rebalancing rules when I set up my investment account and can stick to it. It’s all rules based. The simpler the rebalancing technique, the easier it is to adhere a good plan.”

If you would like to learn more about rebalancing and finding your ideal portfolio diversification, you can schedule a complimentary consultation with one of our CERTIFIED FINANCIAL PLANNER™ Professionals by viewing our calendar. Whether it’s meeting in person, virtually, or by phone, we’re committed to helping you live your one best financial life.

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.