Today we explain the concept of rebalancing your portfolio. Why it is important and what it does.

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Episode 028 – Rebalance

Episode 028 – Rebalance.mp4

This is Market Insights from Southwest Investments, where we dig into current events and how they affect the markets but also how they might impact your financial future.


Rick:                 Welcome to Southwest Investments Market Insights webcast. I’m your host, Rick Zich. With me today is going to be Bart Schannep. Bart’s going to dig into some things that we talk about every time you come in for an annual rebalance or an annual review of your account.

Basically what we’re doing is we’re identifying which funds, which mutual funds, which ETFs have performed really well and might have brought your account out of balance. We want to bring it back into balance. Bart is going to dig into what that really means and what’s behind that. Bart, I appreciate you joining us today. Why don’t you dig into some of those things?


Bart:                 I certainly can, Rick. Thank you for having me on. The easiest way for me to explain rebalancing is think in terms of, well, here’s a good example. Say you’re dropped on an island and there are only two companies you can invest in. You can invest in an umbrella company or a golf course company. The only other piece of information you have is that it literally rains every other day.

Okay. You get there. You land, and you invest equally into each company. First day, rains like crazy. The umbrella company goes up. Second day, dry, no rain. The umbrella company goes down, but the golf course company goes up. Next day and vice versa. What you can see is your money would eventually or essentially just move up and down with what’s happening.

With rebalancing, let’s say it rains like crazy. The umbrella stock goes up. The golf course stock goes down. At the end of the day, take your profits from the umbrella company and buy more cheaper golf course stock. The next day, dry as a bone. Everyone’s out playing golf. The umbrella stock goes down. The golf course stock goes up, but you now have more shares because yesterday you were able to buy cheaper shares.

Well, now that the weather’s nice and everyone’s playing golf, you can sell some of your profits, take some of your profits out, sell some of your expensive golf course stock and buy cheaper umbrella stock. Instead of day by day your portfolio going like this, because you keep taking profits from the winners and adding to the losers, you can make your portfolio climb like that. That’s the best way for me to describe rebalancing.

Now, after that it gets a little more difficult. Do you rebalance? In the real world, we’re not using just two stocks, golf course and umbrella. We’re using broader based asset classes, large cap US, small cap US, international bonds. Maybe commodities are mixed in there, even money market.

When you get the proper mix of assets for you, for your risk tolerance, then do you rebalance annually, semi-annually, monthly, weekly, even daily if you’re a day trader? Well, we have found that from a historic standpoint, statistically the best is annually. Now, we certainly cheat when people add money or need to take money out. We’ll rebalance at that time. Otherwise, in a static world, the best bet is probably for us, we believe, annually.

Other people disagree. It should have nothing to do with time, should have to do with if one of the asset classes gets more than one percent out of whack, three percent, five percent, 10 percent. There’s no magic number, just a number, a percentage out of whack, then you should rebalance.

There is a flaw in that that if one of your investments, one of your asset classes tears off on a run, you maybe haven’t given it enough movement to really make a difference. That’s what we find with rebalancing. It isn’t necessarily about trying to improve performance, although with my golf course and umbrella example, you can see it does help with performance, but the other main thing is reduction of risk.

In reducing risk, what you’re doing is you’re protecting. You’re keeping yourself from having too much assets in the wrong category at the timing that maybe such a category takes a real beating. You control risk by not letting any asset class get too large. What it does is it also gives you something to do. Yes, that’s what I said, something to do. We are hardwired to do the wrong thing at the wrong time. When the markets go down so steeply, people feel like they have to do something.

I’m going to borrow this. Warren Buffet’s mentor, Benjamin Graham, once said that the active rebalancing simply gives investors something to do. It lets them blow off some of the energy, bleed off some of the energy that when people feel like things are going bad and I’ve got to do something, okay, then let’s rebalance.

Let’s move out of whatever asset class maybe did the best and add more to the asset class that did the worst because we’re at least buying something cheaper so that when the normal state resumes, that which we bought at a cheaper price will give us the reward. That’s rebalancing in a nutshell. I hope this helps.


Rick:                 Well, it certainly did, Bart. That, I think, broke it down really, really simple for those that come into the office and maybe just want a little bit more information about what a rebalance actually does. I appreciate that insight on there.

One of the things that I would also like to talk about is that as you watch these videos, don’t be afraid to go into our contact page and send us any questions that you have about this. I’d be happy to bring it up on the next webcast or just send you the answer directly so that we can make sure that you’re being taken care of. Please, feel free to go ahead and send us that information. I appreciate you being here and look forward to seeing you again next week. Thank you so much.