September 17, 2018
Chris Haverland, CFA, Global Asset Allocation Strategist
Time for a Portfolio Tune-up
- Portfolio drift can occur when markets have substantial appreciation. Without regular, periodic rebalancing, this can lead to an asset allocation that does not align with an investor’s risk profile and goals.
- After the longest U.S. equity bull market in history, portfolios that have not been rebalanced are likely overweight in riskier assets.
What it May Mean for Investors
- This may be an ideal time for a portfolio tune-up, and rebalancing, to align your investments with your goals and risk tolerance.
It’s recommended that you schedule a periodic tune-up for your car to increase efficiency and help avoid potential breakdowns. Investors should follow a similar philosophy when it comes to their investment portfolios. Fine-tuning one’s asset allocation on a regular basis or when life events occur will help to align investment goals with risk tolerance and time horizon. Even if nothing has changed personally, the financial markets likely have moved since the last check-up, which can cause alterations to a portfolio’s composition. This is often called portfolio drift—and it can be addressed by periodically rebalancing allocations back to strategic target weights.
The concept of regular rebalancing often can facilitate “selling high and buying low” without emotional influence, by the sheer discipline of periodic reallocation. How we feel about the markets should take a back seat to market fundamentals. However, our emotions can take control, often leading to poor investment decision-making. In some cases, it can promote market timing, which can be extremely difficult—with most investors picking the wrong time to move in and out of markets. Setting a rebalancing schedule normally (whether it is quarterly or annually) is one of the best ways to remain engaged in the financial markets while maintaining your preset investment risk profile.
The past 12 months have been volatile for the equity markets—with most major indices experiencing a correction (a loss of 10% or more). Over this period, there has been a stark contrast between U.S. equity returns (many in the double digits) and international equity returns (flat to slightly positive), while fixed income generally has been flat to slightly negative. These divergences have provided potential opportunities for investors who employ tactical asset allocation and for those who rebalance their portfolios on a regular basis. In Chart 1, the first pie chart shows how a hypothetical 60% S&P 500/40% Bloomberg Barclays U.S. Aggregate Bond Index allocation that was rebalanced might have looked after the past year. The second pie chart shows this same initial investment mix when the portfolio was not rebalanced. The allocation to riskier assets increased in the portfolio that was not rebalanced—likely causing a mismatch to an investor’s original risk profile. This drift is also evident when isolating the equity allocation. When the portfolio has not been rebalanced, it likely has an overallocation to U.S. equities relative to international equities. Furthermore, the magnitude of this misalignment could be even more pronounced if investors haven’t rebalanced during the current U.S. equity bull market.
We expect increased financial-market volatility in the coming months due to trade headlines, the midterm elections, monetary policy actions, and seasonal weakness. Investors can prepare for elevated volatility through proper investment strategy. History shows that this is a better approach than trying to time the best entry and exit points. This includes setting aside cash for immediate needs, understanding your time horizon, designing an investment allocation based on your goals and risk tolerance, diversifying among multiple asset classes, and employing a consistent rebalancing plan. Once an investor has an investment plan, it is important to stick with it. Deviating from the target asset allocation can add unwanted risk to a portfolio and reduce the probability of an investor meeting long-term investment goals. Now may be a good time for investors to revisit their overall investment plan and determine if their portfolio is properly tuned and aligns with their goals and risk tolerance.