The fundamentals of rebalancing your portfolio

We often get questions about rebalancing portfolios and when to do it. What should trigger a rebalancing? Should it be done every January or should it follow a criteria based on numbers? What about tax implications? And how do I know when to get a pro involved? Let’s tackle these three questions one at a time.

January: A great time for resolutions, but not necessarily the “right time” to rebalance

The January question comes up for this reason; since 1950, December is historically the best performing month for the S&P 500. That being the case, January seems like it would be a logical time to rebalance and set the stage for a successful year to come. That’s only true, however, when an investor lacks the ability to dynamically rebalance a portfolio.

Balancing a portfolio dynamically means that attention is paid, not to the time of year, but to the ratios of a specific portfolio. Market conditions are constantly changing, and there’s nothing inherently special about turning the page of a calendar. What matters is when portfolio holdings advance beyond expected historical norms.

What’s more, is this critical point: the S&P 500 only represents the 500 largest US publicly traded companies, based on market capitalization. It’s a helpful guide. But it doesn’t necessarily represent the mix of any one individual’s portfolio, which is based on their unique goals and tolerance for risk. This individual makes a dynamic approach that much more important.

Rebalancing frequency: Actually, it’s more about discipline and process.

Ask 5 different financial professionals about rebalancing and “best practices,” and you know exactly what will happen. You’ll get 5 different answers. What really matters is having a disciplined approach that takes emotion out of the equation. What investors often fail to realize is that emotional decisions tend to introduce more risk, leading to lower performance.

A systematic approach makes the time of year and guidelines on frequency somewhat irrelevant. What is relevant is a focus on continual portfolio due diligence and tactical investment opportunities based on the investor’s asset allocation plan.

The first step is to work diligently to set the proper asset allocation and then create a rebalancing process and methodology to help achieve the appropriate long-term risk-adjusted return objectives.

Krilogy Financial utilizes a proprietary process, using deviation-driven tolerance bands. They’re individual standards unique to each portfolio position and customized to each client portfolio based on inception date.

Rebalancing and taxes: The secret’s in the sauce.

Most investors are unable to appreciate the great advantages we now have due to technology. At one time it was cumbersome and expensive. Today’s tools allow us to automate the process. We see an example of this in the semi-annual rebalance in our company retirement plan. It shows up in our statements without fanfare.

What’s important to note, however, is that it’s not only being done, but that it’s being done in a cost-effective way to you, as the investor. It is critical to seriously consider tax implications and costs associated with rebalancing.

In other words, if a rebalance were to trigger a short-term capital gain taxed at an individual’s income tax bracket rate, it’s not a welcome experience by most investors. However, having a disciplined process in realizing some gains as investments appreciate through taking more tax-favorable long-term gains is most often not a bad thing. Investors who are serious about maximizing efficiencies from a tax standpoint can benefit from the additional time and effort involved.

Considering help from a pro? Arm yourself with great questions.

In deciding whether to consider getting help in re-balancing your assets, it’s important to determine whether you have the time, resources, interest and expertise. If the answer is no to any of those, we would suggest interviewing several wealth management firms, inquiring about the fiduciary standard in caring for your assets (if there is one), and to come prepared with a list of questions inquiring about processes, such as the methodology and implementation standard for rebalancing client accounts. Be sure you understand how fees are charged, and have an overall comfort level that the advisor you choose has your best interests and goals at the forefront – at all times. As fiduciaries, the Krilogy team does just that, and can help you with your rebalancing questions or any other wealth management issues you may face.