Year-End Rebalancing

Question:  Should I think about rebalancing my portfolio?

Answer: After this past year’s run up in the stock market, it’s a good idea to see if the mix between stocks and bonds in your investment portfolio still matches your allocation targets or if it has shifted over time. It’s likely that you designed your portfolio to match your goals, needs and risk appetite with percentages held in specific assets classes to help balance risks while working toward your longer-term objectives. We’ll focus on the two primary categories for rebalancing: equities and fixed income, or stocks and bonds.

Stocks are generally used for growth and dividend income (total return) while bonds are typically earmarked with the primary purpose of capital preservation. The known maturity date, price, and stream of cash flows that come with owning bonds provide qualities that may help to preserve wealth.

Rebalancing ensures that the blend between stocks and bonds stays within your risk tolerance and that stock market performance hasn’t pulled allocations too far away from targets. By taking some of the wealth created on the equity side during a time where stocks outpaced bonds, rebalancing moves some of the equity portion back to the fixed income side of a portfolio in efforts to preserve the newly created wealth. The strong 2021 year-to-date stock market performance has likely pushed many investors away from their target portfolio allocations.

The chart simply illustrates a $1,000,000 portfolio allocated with 60% in equities and 40% in fixed income. After a runup in the stock market, this investor would be under-allocated to the capital preservation portion of their portfolio (fixed income) by nearly $60,000. Simply put: this investor currently has a riskier portfolio than they targeted. Year-end rebalancing would mean moving ~$60,000 out of equities and into fixing income to move back into alignment.

An annual review provides the opportunity to take a fresh look at your portfolio with your financial advisor and determine if your current asset allocation matches your intended targets, long-term goals, and risk tolerance. Keep in mind as you’re rebalancing your portfolio, or anytime an investment is being sold, is the tax consequences of selling investments. Depending on personal situations, losses can sometimes be “captured” to offset current or future capital gains. 

Regardless of interest rate levels, fixed income’s unique attributes make it an ideal investment for wealth preservation. Individual bonds endure ups and downs, potentially reducing the stress of external market forces and volatility. For most, fixed income is a core component to an overall investment strategy. Here are ten reasons to consider bonds: 

1. Individual bonds have a known income stream that won’t deviate from the day of purchase to the day of maturity. It is one of the few investment vehicles where the holding period return can be calculated at purchase.

2. Individual bonds have a specific maturity date when the entire face value will be returned regardless of interest rate fluctuations, supply/demand issues, politics, policy changes or other outside variables moving the markets during the holding period.

3. Cash flows will remain constant throughout the holding period.

4. Cash flows can be controlled by the investor to meet their individual needs. Through coupon selection, investors can increase cash flows to meet specific liquidity needs.

5. Bonds may not make you wealthy, but they can keep you wealthy. Having a known maturity, known cash flow, and known income provides a core foundation for your plan. In a year when stock values have created wealth, bonds can preserve it.

6. Investment grade bonds have a very high credit quality and therefore very low historical default rate.

7. Bonds can be selected to meet very specific needs for maturing and rate of return offering a tailored approach to match personal asset allocations.

8. Individual bonds don’t rely on the ability to predict the future and can provide solid benefits when held to maturity.

9. There is complete transparency (you know exactly what you own and how it will perform) when you hold individual bonds. 

10. Regardless of market interest rate levels or changing market variables, benefits one through nine are in play.

Stay focused and plan accordingly.