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Portfolio balance 101

Portfolio balance 101

| September 19, 2016
Investing

"The four most dangerous words in investing are: 'this time it's different.'" - Sir John Templeton

If the way we build our portfolio, called our asset allocation is our first line of defense against changing markets, how do we keep our defense in-tact? We rebalance, that's how. Let's define what this means. Sorry I’m not sorry but I need to nerd out for a moment. To understand why we rebalance, we need to know what it means to be in balance. At Engage, our strategic portfolio construction process consists broadly of the purchase of equities, fixed income, and alternatives. We further sub-divide these into many sub-categories such as US large-cap growth, international value, emerging market debt, investment grade bonds, MLPs, REITs, and many more. The optimal balance is found based upon many factors which vary significantly client to client. Some of these factors are age, health, risk tolerance, income, assets, background, family, and again, many others. When properly balanced, the portfolio seeks a certain range of performance for a certain degree of risk over a specific period of time. 


So what is rebalancing? It is the act of buying and selling assets within our custom-built strategic allocation to achieve the long-term balance of risk and return that the portfolio is intended to have. As a basic example, let’s look at a blend of 60% (s)tocks and 40% (b)onds. If we had a good year in stocks, a bad year in bonds, our portfolio may have shifted from 60(s)/40(b) to 70(s)/30(b). This portfolio now has more market risk than we intended. To rebalance, we sell stocks equal to 10% of the portfolio and buy bonds equal to 10% of the portfolio and thus restore our 60(s)/40(b) blend. One quick note, rebalancing may have tax consequences or cost you sales commissions. Before rebalancing, it’s important to understand what the potential costs are, especially considering sales compensation if there is any.

Rebalancing is a type risk management that is incredibly important in achieving our financial goals. We try to invest within a range of risk that we can handle for a potential return we desire. Rebalancing helps to keep us within that range when our individual investment strategies change in value. When our portfolio is meeting expectations, it helps us to make better decisions and stick to our financial plan. Too much/too little risk/return can stimulate feelings of fear or greed which in turn can cause us to buy high, sell low, try to time the market, purchasing bad investments and so on. So we recommend rebalancing regularly, hopefully at least once a year. Not just to keep our portfolios in balance, but to keep our emotions and expectations in check as well.