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Portfolio Rebalancing for Better Returns!

School is back in session!  As part of the back to school preparation I am sure there were lots of haircuts over the last few days.  Years ago I heard a financial advisor trainer compare rebalancing an investment portfolio to getting a haircut.  Some people do it on a set schedule, others when they feel they need it, and others simply never get their hair cut.  While the analogy made sense for understanding different approaches to rebalancing, it told me nothing about the results.  Yeah, the hair may have looked nicer, but did it grow faster afterwards based on one philosophy over another?  Unfortunately, he did not have the answer.

This weekend I was skimming back through Ben Carlson’s A Wealth of Common Sense and the topic of rebalancing and moving forward was covered.  Again, if you haven’t read his book I highly recommend it!  Every investor has heard the terms of Asset Allocation, Diversification and Rebalancing.  These three concepts work hand in hand with one another and are critical to your success as an investor.  Going back through the book I noticed some rebalancing data that had not jumped out at me before.

Rebalancing is simply bringing your portfolio back to the asset allocation you have established.  There are all kinds of different rules for rebalancing.  They can be time dependent, such as rebalancing quarterly, semi-annually or annually.  You can also rebalance based on percentages, which is the philosophy I practice.  There are also people who say to never rebalance, which does work but drastically increases volatility.  I guess in the world of rebalancing and haircuts, this would be the Crystal Gayle approach.

In his book, Ben takes a look at the performance numbers for three different stock markets from 1970 through 2014.  The markets were European, Pacific and US ones.  Their average annual returns respectively were 10.5%, 9.5% and 10.4%.  Now, this is where it gets interesting.  He created an equal-weighted portfolio allocation with an annual year-end rebalance back to these equal weights.  Once he did this the actual average annual return of this newly combined portfolio was 10.8%, higher than any of the three individual markets.

These increased results were from selling the winners and buying the losers.  Each market had years where they were the winners and others where they lagged the others.  The goal with rebalancing was to improve risk management and the results ended up being the beneficiary.  Ben states that if you “take care of the risk and the returns should take care of themselves.”  I guess this is what you would call a win-win.

My advice for you is to make sure you have a financial planner who is looking at your whole picture when it comes to asset allocation, diversification and rebalancing, and not just the account(s) he is directly managing.  Unfortunately, I often see the latter situation as many advisors are only concerned about the account they are being paid on.  Otherwise you may walk out with a mullet as your advisor only took care of the front of your hair.  Not that there is anything wrong with a mullet!

About Dan Johnson, CFP

I am the President and CCO of Forward Thinking Wealth Management, LLC, which is the flat-fee financial planning firm located in Akron, OH, and set up to work virtually with clients across the country. I charge clients a flat fee of $4,800 regardless of asset size. My firm is a solution to what I feel is a broken system where clients pay advisors based on something out of their control - the performance of the market.
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