Force your Portfolio to be Disciplined in 2014

Rebalance Cartoon

Congratulations Mr. Market…you’ve delivered a tremendous year of returns to equity investors!  With the broad equity markets delivering returns over 25% (S&P =29%, DJIA = 25% and the NASDAQ = 37% as of 12/27/2013) investors are now faced with the question of what to do now?  For those investors that were invested in stocks, especially domestic stocks, year-end statements are going to look very impressive but remember that is only on paper. As we step into 2014 what should investors do with their portfolios?

Often investors choose to go with an adage commonly heard in casinos – “Let it ride!” Although the market defied odds and dodged several ominous obstacles, there is no guarantee that it will continue to do so going forward.  Sitting back and doing nothing could very well allow those returns to dwindle away and become nothing but a memory.  It wasn’t that long ago that ‘The Tech Bubble’ hit investors with a strong left uppercut that they never saw coming.  Mr. Market delivered three years of impressive returns (1997 = 33%, 1998 = 28% & 1999 = 21%) only to see it disappear with three consecutive years of negative returns (2000 = -9%, 2001 = -11%, 2002 = -22%) and let’s not forget 2008 (-37%).   How can investors avoid repeating history while also managing the risk and unrealized gains in their portfolio? 

What it essentially comes down to is the concept of rebalancing. Let’s say you started out the year with your portfolio balanced within the allocation that is appropriate for your risk tolerance.  After a year like this you would find that the weighting of each asset class has changed drastically based on market returns.  If an investor started the year with an allocation of 50% equity and 50% fixed income it could easily now have in excess of 60% equity and under 40% in fixed income.  While your portfolio had a great year your risk tolerance has suddenly moved substantially higher.

Rebalancing is simply the process of selling and buying portions of your portfolio in order to set the weight of each asset allocation back to its original state.  This can be a very challenging process as it requires investors sell their best performing positions and buy more of those that have been underperforming.  Selling winners and buying losers!?  Doesn’t that sound like a recipe for failure!?

At first glimpse it certainly does, however, if you dig a bit deeper and look at some time-tested data it looks more like a recipe for success.  Perhaps a more accurate summary is selling into strength and buying into weakness or selling high and buying low.  Rebalancing forces your hand to be a disciplined investor! Investors will get a higher price for their ‘winners’ – rather than letting future market performance possibly take back returns and getting a bargain on ‘out of favor’ assets.

There is an art and science to rebalancing.  Investors need to remember that their portfolio does not need to be static and only hold a set number of positions.  For example if you owned a general bond fund you don’t have to go in and buy more of that same holding.  The average general bond ETF (Exchange Traded Fund) is down -4% to -5% this year.  Perhaps you should consider buying a bond fund with a shorter maturity and higher quality based on the current fixed income environment.  There are many other options to explore within each asset class.  For example if find that you need to add International exposure within your portfolio you can look at several different options: developed, emerging, region specific, frontier, country specific or a position that captures everything.

Rebalancing can be as difficult as the investor wants to make it.  Here is a list of some things to consider:

  • Do you have a plan?  Do you know what your target allocation is?  If you do, how long has it been since you revisited it?  The majority of returns in any portfolio are driven by the allocation and not market timing or the next hot stock pick.
  • Utilize tools – most financial firms have a portfolio monitoring or rebalancing tool you can utilize.  There are also numerous online tools available.
  • Transaction fees – while you certainly don’t want to base any rebalancing on the fees that you will incur you do want to be aware of what the overall expense will be.  Perhaps it is time to explore other financial firms that offer lower transaction fees?
  • Taxes –Don’t let the ‘tax tail wag the investment dog’ but you also don’t want to be alarmed by a large unexpected tax bill.  Take the time to look not only at the positions that have done well but also those that have underperformed to see if they will cancel each other out.  Consider making some smart “Tax Loss Harvesting” moves.
  • Investment options – We’ve discussed this topic in many of our previous articles.  Just because you’ve always owned mutual funds does not mean that you need to continue to do so!  Explore other options and compare not only the performance but fees, turnover, beta, and how your investment stacks up to its relative benchmark.
  • Be aware of new asset classes – Your portfolio does not need to consist of strictly equities, fixed income and cash.  There are many other investment options to consider these days and investors need to consider if they have a place in their portfolio.  What is your current exposure to Alternatives?
  • Look at your entire portfolio – don’t look at just your taxable account or just your retirement plan.  Look at the entire picture and allow them to work together towards your goals.
  •  Don’t allow yourself to be overwhelmed and end up doing nothing!

While the act of rebalancing appears fairly simple, actually implementing it can be a daunting task to many.  The last bullet point is one that we hear all to often in that investors don’t want to make the same mistake they back in the early 2000’s or even more recently in 2008.  Don’t bury your head and push your accounts to the side – make your portfolio one of your New Year’s resolutions that you will follow through with and make it a priority.  If you find yourself in over your head then find a professional that can help you.

“The hard part of investing isn’t coming up with a plan, it is sticking to it, especially when that means taking profits off the table and having to put that money into categories that don’t look as good.” – Charles Rotblut, vice president of the American Association of Individual Investors.

If we can be of any assistance please don’t hesitate to contact us at your convenience.  If you found this article helpful – here is another article that we wrote over three years ago on this topic:  Is Your Portfolio Injured?  Try RICE!

We wish everyone a Happy, Safe and Prosperous New Year!!

1 thought on “Force your Portfolio to be Disciplined in 2014

  1. Pingback: Even a broken clock is right twice a day | Dear Mr. Market:

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