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Financial Planning Series: Why rebalance your investment portfolio?

| February 17, 2022
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In this article regarding our Financial Planning services, we outline why someone would consider rebalancing their investments. Rebalancing is a critical aspect of our disciplined philosophy for investing.  Over the long term, stocks have historically provided higher returns than bonds.  However, those higher returns came at the expense of higher risk, specifically, steeper drops in market value in bad years.  In other words, a bad year in stocks has historically tended to be far worse than a bad year in bonds.  As an example, 2013 is the only calendar year since the late 1990s that the Bloomberg Barclays Aggregate Bond index had a negative return.  In that year, its total return was -2.02%.  Compare this to the S&P 500 which, in 2008, had a total return of -37%.  The first lesson is that adding bonds to a portfolio can help smooth out the volatility of a portfolio.  Second, it is because of these different risk/return characteristics that we need a method to help ensure that investment portfolio doesn’t stray too far from its goals.  Rebalancing is the primary means of accomplishing this objective.


In order to better understand why rebalancing is important, it may help to review some key differences between stocks and bonds.  Again, one primary reason bonds are held in a portfolio is to help provide stability, offsetting some of the volatility inherent in stock investing.  Since they are debt instruments, the vast majority of the returns from bonds over time comes from interest payments.  With the principal amount generally being fixed, capital appreciation is typically not something investors expect from bonds to any meaningful degree, although there are some exceptions.  Contrast this with stocks, which represent an ownership interest in a company.  Stock returns are typically driven by the ability to increase earnings over time and grow the value of the business.  As a result, stock returns come mostly from capital appreciation as opposed to contractually-binding fixed interest payments.  If things go south for a company, creditors (bondholders) get paid before owners (stockholders).  Because of these different characteristics, it is important to maintain the right mix between the two.


So what exactly is rebalancing? Rebalancing is the discipline of selling assets that have appreciated in value and reinvesting the proceeds into assets that have not appreciated as much or that have even experienced a decline in value.  A primary reason for this discipline is to avoid a situation where a portfolio has too much money in stocks heading into a market downturn, exposing it to greater losses than intended.  The periodic rebalancing that our advisors provide helps maintain this discipline and avoids letting a portfolio stray too far from its objectives.  When we experience a strong stock market, rebalancing typically means reducing stocks, which have performed well, in order to increase holdings in bonds.  In a situation where stocks experience a significant decline, our advisors would be doing the opposite.  When stocks decline and are underweighted in portfolios, our advisors would actually sell bonds and increase stocks in order to maintain the same disciplined investment philosophy.  As a general guideline, our advisors don’t want a portfolio’s exposure to stocks to stray more than 5% above or below that portfolio’s targeted stock weighting.  For example, this means that if a portfolio has a 55% stock allocation target, they would definitely want to rebalance any time the stock exposure exceeded 60% or fell below 50%.  This discipline helps to ensure they are taking an appropriate level of risk in that portfolio.


This then begs the critical question, “How do I know how much risk I should be taking in my portfolio?”  Everyone’s situation is different and there are a number of different factors that go into determining what is appropriate for you.  Our advisors help clients answer this question every day with comprehensive financial planning.  The financial planning process is designed to gain an understanding of your needs and objectives and, with that understanding, put the pieces of your financial picture together to help meet your goals.  Investments are certainly an important part of that financial picture and the planning process guides them in making sure the risk level for each piece of that picture is appropriate for you.  Once they have a plan in place, rebalancing is one of the tools they employ to help you stay on track.  If you aren’t sure where to start, or if it has just been a while since you have revisited your plan, we would welcome the opportunity to help be a part of that process.  For more information or to speak with a financial advisor at Capital Analysts of Jacksonville, contact us at (904)730-7433.


Source: Morningstar Advisor Workstation (accessed data on 7-25-19)


Disclaimer:  This content was developed from sources believed to be providing accurate information. The information in this material is not intended to provide legal or tax advice. You should consult your legal or tax advisor for information concerning your individual situation.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.  Barclays U.S. Aggregate Bond Index is a composite of four major sub-indexes: US Government Index, US Credit Index, US Mortgage-Backed Securities Index, and US Asset-Based Securities Index, including securities that are of investment grade quality or better, have at least one year to maturity, and have an outstanding par value of at least $100 million.  S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market.  Investors cannot invest directly in an index.

Advisory services offered through Capital Analysts and Lincoln Investment, Registered Investment Advisers. Securities offered through Lincoln Investment, Broker/Dealer, Member FINRA/SIPC. Capital Analysts of Jacksonville, Florida, Inc. and the above firms are independent and non-affiliated.

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