Reviewing Rebalancing Strategies

Key Points – Reviewing Rebalancing Strategies

What’s a Goldilocks Portfolio?
Offensive and Defensive Rebalancing
Finding Your Ideal Asset Allocation
Why Reviewing Rebalancing Strategies Can Be Even More Critical for Retirees
5 Minutes to Read | 24 Minutes to Watch

A Flashback to Two Years Ago

Does two years ago feel more like 20 years ago to you? It can certainly feel that way when thinking about the markets. When Dean Barber and Bud Kasper mentioned the idea of reviewing rebalancing strategies to people two years ago, some of them thought they were crazy. After all, the stock market was on a tear and had been thriving since April 2020.

Well, we all know how 2022 turned out, as we saw double-digit negative returns in stocks and bonds. It didn’t take long to see why Dean and Bud were talking about reviewing rebalancing strategies.

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The Goldilocks Portfolio

One of Warren Buffett’s famous quotes is to “be fearful when others are greedy and to be greedy when others are fearful.” That can be a very difficult mantra to follow when the markets are thriving or when the markets are struggling. It’s critical to not let fear and greed take over when you’re investing.

Dean and Bud like to take the Goldilocks approach to investing. You don’t want your portfolio to get too hot (letting greed settle in) or too cold (to the point where fear takes over). You want it to be just right.

At the end of June 2023, Dean and Bud discussed why it might be a good idea to look into doing a mid-year rebalance. They reviewed how the markets had performed for the first six months of 2023 and shared what to consider with rebalancing strategies. Now that we’re approaching the end of 2023, they’re going to do the same thing. Again, you don’t want your portfolio getting too hot or too cold. You want it to be just right.

What Have the Markets Been up to?

If you’ve been tuning into Dean’s Monthly Economic Updates, you’ve heard him talk a lot about the Magnificent Seven in 2023. For much of the year, Microsoft, Apple, Nvidia, Amazon, Tesla, Meta, and Google did the heavy lifting in the cap-weighted S&P 500—making up around 25% of the market’s return. The cap-weighted S&P 500 strongly out-performed the equal-weighted S&P 500 because of that for most of 2023.

That changed in November, though, as a broad-based market rally began for the first time since February. Did you go those 10 months between broad-based market rallies without rebalancing? Or did you rebalance your portfolio during that stretch after seeing how the Magnificent Seven was carrying the markets?

We’ve seen a lot of volatility in the markets over the past few years. While that volatility can be uncomfortable at times, it’s important to remember that it’s not abnormal. We strongly recommend reviewing your rebalancing strategies at least once, if not twice a year.

“The topic of rebalancing has been around for a long time, yet it doesn’t get utilized nearly as much as it should. Probably some of the biggest offenders of not rebalancing are the DIY investors.” – Dean Barber

What’s Your Ideal Asset Allocation?

Each person is going to have their different level of comfort as far as investment risk goes. That level of risk is going to help you identify your ideal asset allocation within your portfolio. Your asset allocation will outline how much you have in stocks, bonds, cash, international, etc. Those assets are going to perform differently over the course of time, which directly impacts your ideal asset allocation.

“Proper asset allocation to drive a certain rate of return is the single largest driving factor of long-term performance. However, the individual psyche oftentimes doesn’t let the individual investor do that because they’re not coming at it from an academic standpoint. They’re coming at it from an emotional standpoint.” – Dean Barber

For example, let’s say you started 2023 with a 60-40 portfolio—meaning that you had 60% in equities and 40% in fixed income. Stocks were up far more than bonds to begin the year, so you weren’t at 60-40 for that long. You were probably closer to 70-30.

At that point, you should ask yourself whether you should go back to having a 60-40 portfolio and protecting some or your gains or let it ride? This goes back to what Warren Buffett was saying about fear and greed and striving to have a goldilocks portfolio. As we head into 2024, figure out what your ideal asset allocation is. If you’re starting to get away from it, it might be time to review your rebalancing strategies.

Offensive and Defensive Rebalancing

Doing a rebalance in the situation we just covered would be an example of defensive rebalancing. You’ve had some gains in your portfolio and you want to protect them by rebalancing your portfolio from a risk perspective.

In the event the markets aren’t doing well, that’s where offensive rebalancing comes in. You need to figure out how to reapply money back into those assets that haven’t given you the best returns to hopefully get them down the road.

Those are just a couple of basic ways to approach rebalancing. The bottom line is that you need to take a dynamic approach as you’re reviewing rebalancing strategies. Once we create your financial plan, we want to determine from a historical perspective what asset allocation gives you the highest probability of success with the least amount of risk? That will be your ideal asset allocation at that time.

The reason we say it needs to be dynamic is largely because of what we’ve already discussed. Markets can be very volatile, which greatly influence your feelings about market risk. Again, staying as level-headed as possible is crucial. As the markets and your personal situation changes, don’t let too much time go by without reviewing rebalancing strategies.

Reviewing Rebalancing Strategies for Retirees

It’s important for all investors to review rebalancing strategies a couple of times a year, but it’s even more imperative for retirees. Why? Because there are a lot of retirees that need their portfolios to drive income for them. One of the main goals of our CFP® Professionals is to build portfolios that deliver people income as they’re approaching and going through retirement.

Remember that there’s a big difference between your investment portfolio and a comprehensive financial plan. Your investments will serve as the engine that makes your plan run. It’s crucial to have a financial plan that incorporates your tax planning, estate planning, and risk management needs as well as your investments.

Yes, your investments are important, but your retirement plan will be far from complete without those other components of a financial plan. You can really see how this is the case if you download and review our Retirement Plan Checklist. It consists of 30 yes-or-no questions and an age-based timeline of several key retirement considerations. Download your copy below.

Retirement Plan Checklist

“In our Retirement Plan Checklist, we ask if your retirement plan has been stress tested to take in consideration poor market conditions at any point in your retirement. You need to be able to say yes to that.” – Dean Barber

Determining Your Safe Withdrawal Rate

Dean and Bud recently reviewed a Morningstar study on safe withdrawal rates that referenced the 4% rule. The term safe withdrawal rate refers to how much retirees can take out of their retirement accounts on an annual basis without potentially outliving their money. The 4% rule might be OK for you to you as a starting point, don’t just withdraw 4% each year and expect to be set.

Just like with reviewing rebalancing strategies, your withdrawal rate should be dynamic. It’s going to depend on your unique situation. For example, let’s say that your withdrawal strategy is getting you a 12% return. That’s great! If you are in the neighborhood of a 4% withdrawal rate, you’re looking at nearly three years’ worth of a return in one year.

“Go ahead and take your gains while you have them and put them in the safer bucket and then balance out the portfolio going forward.” – Bud Kasper, CFP®, AIF®

Rather than letting it ride, why not set some of those returns aside, put them somewhere safe, and review your rebalancing strategies? That way when the market does go through a rough period, you potentially use that money when good returns are hard to come by. Harvesting those gains can make a huge difference in retirement.

Do You Have Questions About Reviewing Rebalancing Strategies?

Rebalancing is going to look different for everyone. You’re not going to have the same earnings history, investments, or financial goals as your best friend even if it feels like you’re attached to them at the hip.

There can be a lot to navigate with reviewing rebalancing strategies, so make sure you’re doing so with a CFP® Professional. They’re obligated to put your needs ahead of their own. If you have any questions about reviewing rebalancing strategies, start a conversation with our team here.

Schedule a Meeting

We’re ready to build you a financial plan that’s designed around your goals. Let’s review your assets and figure out where you’re going to spend from and when to accomplish those goals. Remember, your investments are simply the engine of your plan. We’re going to review rebalancing strategies as you approach and go through retirement so that your plan will be chugging along with plenty of steam.

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Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Adviser. 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.