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Revisiting Asset Allocation and Rebalancing

By: Ted Black, CFP©
Fall 2019 (Vol. 37, No. 3)

Wow, what a difference a year makes! Last year around this time we were in the midst of a steep downtrend in the U.S. stock markets. From the first week of October 2018 through Christmas Eve 2018, the major market indexes (Dow Jones Industrial Average®, S&P 500®, NASDAQ Composite®) all fell around 20% in that roughly ten week period. As of this writing, the markets have recovered all they gave back last year, are sneaking into all-time high territory, and heading towards booking a very solid year.

I much prefer this year’s market action vs. last year, but it serves as a real world reminder that it’s awfully tricky to predict market behavior.

This seems like a good time to revisit a topic we haven’t covered in a few years: Asset Allocation and Rebalancing. As a quick reminder, “Asset Allocation” is the process of creating an investment portfolio that combines different assets (Stocks, Bonds & Cash) in varying proportions, with the ultimate goal of providing an investor with a balance between risk and reward that suits their particular situation. This approach was born from research that demonstrates that over long periods of time, Stocks, Bonds and Cash perform quite differently from one another, and as such, an investor’s mix of these assets proves to be a significant factor in their long term results.

The benefits of balancing risk and reward by dividing their investments among major asset categories such as Stocks, Bonds, and Cash equivalents has long been recognized by savvy investors. Because each of these assets can react quite differently to ever-changing economic and market conditions, diversifying a portfolio among various assets can help reduce volatility, and also has the potential to enhance overall returns. “Asset Allocation” is the process of creating a portfolio that combines different assets in varying proportions, with the underlying goal of providing an investor with an appropriate balance of risk and reward.

For example, let’s assume that after much thought and a careful evaluation of current personal financial conditions and future financial goals, an investor decides that an appropriate asset allocation schedule calls for them to direct 60% of their investments into Stocks, 30% into Bonds, and 10% into Cash or Money Markets. Let’s call this the “base setting”. This may be a great start, and will hopefully set an investor on the road to long-term success. However, the selected investments will almost certainly change in value at different rates. For instance, in any given time frame, Stocks may perform notably better (as they did in 2013) or worse (as they did in 2008) than Bonds and/or Cash. As a result, the percentage of the overall portfolio each investment represents can and will change … sometimes significantly so.

If left untended, after periods in which the assets owned perform significantly different from one another, a portfolio may end up with an asset allocation schedule, and importantly, a risk/reward profile, that is quite different from its original design.

This leads us to the simple but effective idea of “Rebalancing”. Rebalancing is the process of making adjustments (buys and/or sells) to the portfolio to bring the asset allocation schedule back to its “base setting”. And although there are no hard and fast rules as to how often an investor should rebalance their portfolio, a minimum of once per year is recommended.

If you questions about Asset Allocation or Rebalancing and how they may currently apply to your situation, please feel free to call Ted Black, CFP® at 888-878-0001, extension 3.

Advisory services offered through Royal Palm Investment Advisors, Inc., a Registered Investment Advisor.