There’s a regular argument in the investment world that can potentially draw strong opinions depending on who you talk to. Should you regularly rebalance your portfolios, or should you let the winners run? The concept of letting the “winners” run is quite simple. When you rebalance a portfolio, you’re essentially selling out of a position that’s overperforming your other investments to buy back into those underperforming holdings. The theory is you never know what asset class will perform well in the future, so you always want to get back to your original investment allocation. Say for instance you’re in a 60/40 portfolio. The equity portion of your account does particularly well in a given year, and now represents about 70% of your portfolio, vs. the original 60%. Based on your initial risk tolerance, in this scenario you’re now overexposed to equities by 10%. This could potentially lead to greater loss if there’s volatility in the equity market. Or it could potentially lead to missing out on greater returns because you’re cutting short your equity exposure to future returns, strictly in the name of rebalancing.
I very much despise blanket recommendations, and think most of financial planning needs to be customized to the individual. So a lot of times the answer to the question is usually “It Depends.” Generally speaking rebalancing is a great strategy, but rebalancing just for the sake of rebalancing is not helpful. What I want to focus on is if you are going to rebalance, what considerations you’re making when doing so.
At its core, the act of rebalancing is selling something that’s overperforming, and buying back into something that hasn’t done as well. Over time, logic would dictate that the best performing sectors of your portfolio will rotate, so the underperforming sectors would switch and overperform down the line. However, one of the fundamental rules of investing is this: Winners Run, Losers Get Cut.
Investing is highly emotional. People become attached to their stocks or investments. Like a proud father watching his son hit a home run, it’s exhilarating to watch something you’re close to have success. However, if that son strikes out his next three at bats, recency bias would indicate that he’s on a downslide. This is where a coach is needed to substitute in a fresh player, if you will.
Rebalancing is a common and essential strategy, but only if you’re truly evaluating what you’re rebalancing back into. Are your “winners” really overperforming, or are they overperforming relative to the rest of the portfolio? If the answer is the latter, then at that point you’re throwing good money after bad. This is where a financial advisor, or coach, can be instrumental in removing some of the emotion that comes with investing, and making sure that current investment strategies are always staying in line with not only the overall goals of a portfolio, but providing the best opportunity for winners to run as well.
The information given herein is taken from sources that IFP Advisors, LLC, dba Independent Financial Partners (IFP), IFP Securities LLC, dba Independent Financial Partners (IFP), and it advisors believe to be reliable, but it is not guaranteed by us as to accuracy or completeness. This is for informational purposes only and in no event should be construed as an offer to sell or solicitation of an offer to buy any securities or products. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as IFP does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. Securities offered through IFP Securities, LLC, dba Independent Financial Partners (IFP), member FINRA/SIPC. Investment advice offered through IFP Advisors, LLC, dba Independent Financial Partners (IFP), a Registered Investment Adviser. IFP and Family Wealth Planning Partners are not affiliated.