Your Life Simplified

Rebalancing Your Portfolio

January 18, 2024

The one constant in life is change, and the markets are no exception to this, which leads to a familiar question for many investors. When should you rebalance your portfolio, if at all? On this episode of Your Life Simplified, Michael MacKelvie, wealth advisor, is joined by Brad Rollins, vice president of investments. They discuss what rebalancing means and how to get back to your original investment portfolio mix.


Michael MacKelvie: The one constant in life is change, and the markets are no exception to this, which leads to a familiar question for many investors, and that is, When should you rebalance your portfolio, if at all? That’s what we’re here to talk about today.

I am here with Brad Rollins, who is a chartered financial analyst. He’s also the vice president of investments at Mariner. This is Your Life Simplified. Brad, how are you doing, man?

Brad Rollins: I’m good, Michael. How are you?

Michael: I’m good, too. I’m good, too. I know you just got off a long week, and we’re throwing you in it here, but first question I just have for you is maybe just explain what rebalancing is. And I think after that, if you could, talk through the potential benefits of this.

Brad: Yeah, yeah. At the beginning of a relationship with a client, a lot of times we’re spending a lot of time trying to figure out what is the right mix of stocks and bonds and real estate and all of the different things that we may potentially invest in. What’s the right mix for a client? And what happens over time is whatever that mix is, markets go up, markets go down, some things go sideways, but you look up a year later or some period of time later and whatever that original mix was, you don’t own it anymore. Things have drifted. And so what you’re doing when you rebalance is simply getting back to whatever that original targeted asset allocation was to regain those characteristics that we thought were important for your portfolio at the beginning. As the portfolio drifts, you start to get different characteristics, and so it’s just getting back to where we started.

Michael: Yeah, yeah, so there’s maybe an intended goal that you began with with that portfolio, and over time markets can drift, as you mentioned, so stocks maybe can have a wonderful one- or two-year run, in this case, which can throw the portfolio out of whack. Or the alternative, maybe they do much worse than bonds or some other asset class, and the idea is you want to rebalance maybe back to that original asset allocation or somewhere within that. But there’s, I think, some understandable questions with that, and one thing we’ll maybe come back to at the end of this is, there’s people like Jack Bogle that would say, “Hey, I don’t think you should ever rebalance.”

Brad: Sure.

Michael: So, I guess we’ll start with just first, how frequently should somebody consider this? I’ve seen quarterly, I’ve seen annually, I’ve seen maybe an emergency rebalance if we have a large market turn one way or another. How frequently should one do this? And maybe distinguish between the different accounts, if you could.

Brad: Yeah. There’s, I think, a big range of good answers, and so maybe the way to think about kind of defining that range is, we want to do it more frequently than never. It’s a strange place to be disagreeing with Jack, and we’ll get there on Jack Bogle’s “don’t rebalance.” So do it more than never, but also don’t do it too often. And then everywhere in the middle, between never and too often, is probably okay. It comes down to a lot of more nitty-gritty stuff about transaction costs and fees and stuff like that.

But really what you’re doing is when you’re rebalancing your … It’s a risk-reduction exercise. It’s not a return-enhancing exercise, because if you think about it over time, what tends to happen is whatever that top-returning asset is in your portfolio, say you started with a 60/40 portfolio, and the top-returning asset most of the time is probably going to be stocks, and so your portfolio is going to slowly but surely veer more towards being more stock oriented. And so selling down that stock exposure and reinvesting it in something else is typically what it looks like, and that’s a risk-reducing thing, because stocks are the highest return, but they’re also the highest volatility asset that you’re going to own, and so reducing that risk is important.

But when you do that, when you reduce your equity exposure and reinvest in bonds, say, in this example, you’re going to be introducing transaction costs, and those costs come in a few different flavors. One, there’s just whatever you pay the broker or the custodian to place the trade for you, and these days …

Michael: Potentially. Yeah.

Brad: Yeah, those are pretty cheap, right? We don’t pay a lot of attention to those because they’ve come down so much, and equity stocks trade for free, and the big custodians now, it’s not that big of a deal, but it’s something you should keep in mind. There’s just kind of market friction, so when you buy and sell a stock, there’s a bid and an ask spread, and so there’s a little bit of transaction fees. There are costs there, not fees there, but costs there. And then there’s taxes potentially, where you own stock and it went up and now we’re selling it and you’re realizing a gain that you’re going to have to pay taxes on. And all of those factor into how often and how you should rebalance.

If you’re on the too often end of that spectrum, what you end up doing is the benefits of rebalancing are mostly eroded, or can be eroded, by the costs you’ve incurred by rebalancing. So it’s not too often, it’s not every day. It’s probably not even every month. Quarter year is probably good, and it’s not never, because then you end up with a portfolio that just drifts towards whatever your highest-returning and most volatile asset class is. You want to be somewhere in the middle, and I think it’s important that wherever you land with your advisor is you get a plan and you stick to it. And if you said annually, then you do it annually, and that’s the key, and that’s also the hard part.

Michael: Yes, yes, sticking to it, and obviously taxes might play a role, too. If you have a taxable account and the portfolio, I run into this frequently, has maybe seen most of its returns through equities, stocks, and we’re looking at a portfolio that’s maybe 95/5 now when it maybe shouldn’t be. And the question of rebalancing, you got to deal with, okay, well there’s this tax thorn we got to deal with if we do this, which can, I think, push people into holding those positions far longer a lot of times than they should be. But it’s one of those things where if you have to pay the taxes, it’s an understandable roadblock to wanting to rebalance with the taxable account. Of course, you don’t have to worry about this with retirement accounts, but that’s another piece.

But it’s interesting. As you go through that, it’s almost like there’s these competing narratives of sorts. So, you have this idea of I want to have a portfolio that gives me a good expected return, and often over time, since equities tend to have a higher expected return than, let’s say, bonds, the portfolio can shift to be weighted much more that way to have now maybe a higher expected return. That’s one narrative, but then you also have the narrative of, well, I’m getting closer to retirement, or maybe you’re in retirement, and there’s sequence risk that is becoming ever more present. That is the timing of returns because you’re going to be getting closer to replacing your income with this portfolio, let’s say, and so that would give rise to the idea of, well, maybe you should be a little bit more conservative. So you have these two forces that are almost competing with each other as you near retirement.

I see this all the time, and it’s a balancing act to kind of figure out, okay, well, where should we rebalance? Where should we maybe not? How frequently should we do it? It very much is specific to the individuals. You add in another layer of, well, if they got company stock, and they maybe have a very low basis, and we’re talking about rebalancing from one position into many. I mean, it’s very specific to someone’s situation. But I guess another question that kind of brings up is does this kind of give rise to the idea of holding maybe less variable assets such as bonds, even though they have less of an expected return perhaps, with the idea of perhaps opportunistic rebalancing? That’s a term that gets tossed around. I don’t know how you feel about that term, but the idea being if the portfolio sees a large decrease, you maybe can opportunistically rebalance from bonds to stocks that typically have a sharper decrease during those periods. I don’t know what you think of that.

Brad: Yeah. No, I think that’s important, so there are just lower-risk, lower-volatility assets, like bonds, that are good candidates when the market corrects. The stock market corrects, you pull from bonds and add to your stock portfolio. Also, you can do the same thing with just things that maybe aren’t as … they’re maybe not as safe as bonds, but they have a low correlation to stocks. This is where we get to correlation, and some of the things that just don’t act the same as the stocks in your portfolio. And if you have something that is zigging while the stock market zags, that’s another potential pool of money to pull from to go add to the stock market when there’s a correction. And so, it’s looking for the low-volatility assets, it’s looking for assets that aren’t just perfectly correlated with everything else in your portfolio, and then it’s having the discipline to pull from those and add to the market.

That’s one of the things that you didn’t mention when we were talking about tax earlier is just the behavioral aspect of this. Because inevitably, what you’re doing when you rebalance is you’re selling probably one of your best-performing assets.

Michael: Difficult to do.

Brad: Yeah, and you’re reinvesting that money in maybe one of the poorest-performing assets, and that’s hard for people. There’s always, if it’s that the market is corrected, it’s down 25%, and you’re telling me to pull money from my safe assets and put it in stocks? That’s scary.

But that’s why I think agreeing about it, agreeing upon the timeframe or how we’re going to do this in advance, can help people say, “Yeah, this is what we agreed upon. We’re going to do annual. We’re going to do it when it’s down 25% or whatever, and here we are, we’re going to do it.” But on the flip side, too, if the market’s up a ton, that’s also not a fun thing to think about.

Michael: No.

Brad: This is fun. The market’s going up and I’m richer than I was last week, and you’re telling me I should sell this thing that’s going up and reinvest in bonds that just return 4% or 2% or whatever? So, in both ways it can be hard.

Michael: Yeah, it can definitely be hard. I mean, I think perhaps the latter example is even more challenging. I always just think of individuals that have company stock that see that stock just shoot up and how difficult it is for them, because it’s not just that they have to rebalance away from a winner, they also have to pay taxes, typically. And a lot of times, it’s considerable taxes, and even when it’s explained, “You either give this away, you pass away, or you’re probably going to have to pay some taxes”? It still is very difficult to walk away from that position if you’ve seen unbelievable growth.

But yeah, it’s something that, again, is an ongoing issue, as is much of financial planning. It’s not like, “Hey, I just figured this out, and I’m good to go.” New challenges will present themselves, and that behavioral piece that you talked about, we all seem to view ourselves as the exception to. We all seem to view ourselves as the exception to behavioral finance, and that is this idea of prospect theory, the idea that losses, typically on average … There was a Nobel Peace Prize that was won for proving this. Losses typically sting about twice as much as gains, so if you have a loss of 10%, you feel an emotional impact about twice as much as if you had a 10% gain. And when we’re talking about rebalancing, often what we’re trying to do is have a conversation with that future self today, and almost the prospect of that potential future self being a drop in some kind. But again, that’s just a very difficult thing to do before that loss has actually arrived.

So coming back to Jack Bogle, I want you to maybe, if you could, steelman that argument, because obviously a renowned investor, and he would say that he’s in the minority of individuals that would say “don’t rebalance.” Why might he be wrong, and how might he be right?

Brad: Yeah, this is interesting. And when you mentioned this earlier, I had to go back and find where he said that and learn some context, and it seemed to be in some type of “Ask Jack” type of a thing that he was doing for a while where people could write him letters, email him and ask him questions. And so, one of the questions was about rebalancing, and he said, “Yeah, I don’t really do it.” And the stats that he pointed to really focused on returns, and he said, “Look, we did some backtests, we did some studies, and if you’d rebalanced the portfolio, the return would’ve been 7%, and if you didn’t rebalance the portfolio, the return would’ve been 7.2,” or something like that, “So what’s the point? Your return ended up being about the same regardless.” I think he is focused on return based on what he said there.

Back to the beginning of our conversation, we think that rebalancing, and the stats point this out, we think that rebalancing is a risk-reduction exercise. It’s not a return-enhancing exercise, or maybe even a return-reducing exercise. So, I think that if we’d looked deeper at those same time periods that Jack Bogle was looking at, you would’ve seen, yeah, the returns were roughly the same over those periods of time, but I bet dollars to doughnuts that the risk, the volatility, taken by those portfolios was different over the period of time.

If you stretch out to a long enough period, and we looked at, it was actually a Vanguard study, coincidentally, so it’s another one of these things where Jack Bogle says, “Don’t rebalance,” and then we have great Vanguard studies of the firm that he founded, is pointing out the reasons you should rebalance. And so that’s an interesting thing. But Vanguard looked over a long period of time, from the Great Depression through the Great Financial Crisis, and if you never rebalanced a 60/40 portfolio, there was one time period where stocks made up like 96% or 98% of the portfolio from 60/40 all the way up to 98. And there was another period where I think the stocks made up like 33 or 38% of the portfolio. So huge, huge swings.

And so yeah, over a long period of time that may have averaged out to be 7.2, and that was about the same as rebalancing, but that was a wild ride to go from 60 to 98 down to 38 or whatever the numbers were. And the fact is is just most people can’t stand that level of swings and volatility, and there’s some human behavior risk there where people, they tend to abandon whatever we’ve agreed upon and whatever thing that we think we’re going to hold to, we tend to abandon it at the point where it’s just the most uncomfortable.

And those tend to also be the times where it’s the most disadvantageous for you to abandon that principle, right? Let’s not bail out at the very bottom of the market. Let’s not do something that’s just permanently damaging to your wealth. And so, I just think that that’s probably what he was missing is the focus on risk.

Michael: Right.

Brad: To steelman it for a second, I think there are some instances where it could make sense, and one of them is somebody that is just a hundred percent stocks. And if you own just the U.S. stock market, in a market-cap-weighted approach, like the S&P 500, where your largest holdings are also the largest holdings in the stock market, then you don’t really need to rebalance all that much, because if Apple is one of your largest positions and then Apple goes up some more, it went up in your portfolio, and it also went up according to the market cap, which is just kind of the size of the companies relative to each other. And so, you can say that you wouldn’t need to necessarily rebalance an all-equity portfolio that looks a certain way to begin with, because it’s kind of auto-rebalancing, autocorrecting.

Another is if you’re just a Vulcan and you don’t have emotions, and you know what? You can handle the volatility that maybe Jack Bogle can, and the swings are wild, but you know what? I don’t care. You don’t care. But if that were the case for most people, then they probably weren’t in a balanced portfolio to begin with that was 50/50, 60/40, something like that. And if you started out in a balanced portfolio, there’s probably a reason for that. And most people aren’t Vulcans, and the smoothness of that ride matters where most people just can’t say, “Yeah, it’s down 30%,” “It’s down 40%” or whatever and never have any inclination to do something to make a change at the wrong time.

Michael: Yeah. Wonderfully put. And there’s maybe an overconfidence towards Vulcan-ness that many investors have, right? Again, we tend to view ourselves as the exception. I have come across many people that have said that very statement, “Hey, if I lose a considerable amount in this portfolio, that’s totally fine.” And it’s kind of like talking some noise before you actually get into the game, and once you’re actually in the thralls of, let’s just say, some market correction, a considerable one, which typically comes with corrections in other forms, potentially loss of income of some kind to yourself, loss of value to maybe your real estate or something else, that’s when you really know if you’re a Vulcan, which is difficult.

But yeah, I think what Bogle is maybe touching on is if you were purely just a rational being using data, backtesting data, right, in this case, then you wouldn’t do anything. I would say that’s heavily weighting the past for what potential outcomes could be in the future, and I just don’t think there’s a long enough timeline to say that that is the singular best approach universally for individuals, especially given how different risk tolerances are amongst our human clan.

Well, this has been awesome. I appreciate your time, and for anybody that’s listening here, if you’re new, make sure to hit that ‘Subscribe’ button, regardless of what platform you might be listening on, to get more industry insights from individuals like Brad Rollins here at Mariner. Brad, thanks again for coming on.

Brad: Absolutely.

The views expressed in this podcast are for educational purposes only and do not take into account any individual personal, financial, legal or tax considerations. As such, the information contained herein is not intended to be personal, legal, investment or tax advice. Nothing herein should be relied upon as such, and there is no guarantee that any claims made will come to pass. The opinions are based on information and sources of information deemed to be reliable, but Mariner Wealth Advisors does not warrant the accuracy of the information.

Asset allocation/diversification is a strategy designed to manage risk but it cannot ensure a profit or protect against loss in a declining market.

CERTIFIED FINANCIAL PLANNER™, CFP® and federally registered CFP (with flame design) marks (collectively, the “CFP® marks”) are professional certification marks granted in the United States by Certified Financial Planner Board of Standards, Inc. (“CFP Board”). The CFP® certification is a voluntary certification; no federal or state law or regulation requires financial planners to hold the CFP® certification.

Contact Us