(Matson Money) Many successful people tend to take what they learn from different experiences in various aspects of their lives and adjust their approach to their careers, finances, health, relationships—anything important to them—over time. Take fitness, for example. When starting a new program, people often evaluate their progress after the first six weeks to determine: Have I hit my initial target goals? Do I need to increase the amount of weight I’m using or try new exercises to continue to improve?
A similar approach can be followed for investing. A financial advisor constructs a portfolio based on a client’s specific risk tolerance and time horizon. But over time, markets and client situations often change, and advisors should be disciplined about systematically rebalancing client portfolios according to the client’s risk tolerance, in order to help their client achieve their investment objectives.
At Matson Money, we review accounts for rebalancing quarterly, which allows clients the possibility of maintaining a portfolio aligned with their risk tolerance. We use an algorithm that, in addition to enabling us to rebalance thousands of portfolios, can help deter some of the emotional considerations that can lead to imprudent decision-making. While rebalancing does not guarantee the highest returns, it is imprudent to rebalance for returns. If returns were the only consideration, few would bother with asset allocation. “If an investor were to invest in assets that would give the highest returns with no care of risk tolerance…the highest return of opportunity and best investment would be a lottery ticket,” said Mark Matson, Founder and CEO of Matson Money.
Here are three reasons why it’s important to rebalance a portfolio:
1. Risk Management: A common misperception is that advisors rebalance their clients’ portfolios to deliver the highest possible returns. However, rebalancing is actually about risk management.1 When an advisor constructs a diversified portfolio, they are working to ensure that the client will not be allocated 100% to the worst performing asset category—though the opposite is true, too, that they may never be 100% allocated to the top-performing stocks.
2. Buy Low—Sell High: One of the fundamental rules of investing is ‘buy low, sell high.’1 Though this concept might seem simple enough, it can be a lot harder than it looks. Investors who try to ‘time’ the market can invariably end up buying when stocks have hit their peak, selling when the market drops, and buying back in after prices surge, which can cause them to miss out on returns. Rebalancing can force an advisor to sell when equities are overweight and overvalued and buy when they’re underweight and undervalued.
3. Maintain a standard: By rebalancing, advisors can better ensure that clients maintain the same portfolio allocations according to their risk tolerance and considering their investment objectives. Market changes can create an imbalance; over time, as market performance fluctuates, it’s important for advisors to continually rebalance their clients’ portfolios so they remain prudently allocated.
Matson Money adheres to a simple strategy—own stocks, diversify, and rebalance. We also coach advisors and train investors on the potential biases that can thwart these plans. It can be difficult for investors and some advisors to make hard decisions without introducing their own biases. If certain types of equities have been soaring for one, two, or five years, why would you want to sell? Advisor coaches working with Matson Money are trained and developed to guide investors to eliminate the biases that can thwart prudent decision-making and lead to destructive behavior.
When you build a diversified portfolio, you almost always have something to rebalance against. In certain market conditions, rebalancing can effectively control risk and potentially allow for greater returns over the long-term. You want your clients to know why you rebalance and how it happens.
