Call us toll free: 888 332 2238

Managing Your Portfolio

Global diversification provides investors with a valuable tool for managing portfolio risk. But smart diversification has an important responsibility; namely, it requires portfolio maintenance. Once a portfolio is created, asset classes making up the portfolio inevitably will drift out of alignment with their target proportions as some increase in value while others depreciate.

When asset classes drift far enough from their targets, a portfolio should be rebalanced to bring it back into alignment with its original risk and return objective. Rebalancing a portfolio involves selling asset classes that have risen in value and buying more of asset classes that have depreciated.

Why Rebalance?

At first glance, rebalancing seems counter-productive. Why sell a portion of outperforming asset classes and acquire a larger share of underperforming ones? Intuition might suggest that selling previous winners may lower future returns. This logic is flawed, however, because past performance may not continue and there’s no reliable way to predict the future.

By using the plan, not recent performance, to drive investment decisions, periodic rebalancing restores a portfolio to its original risk and return priorities. It also encourages unemotional decision-making, especially during times of market volatility.

Challenges and Decision Factors

When asset class returns diverge quickly and repeatedly, profitable rebalancing opportunities may occur more frequently. When asset classes tend to move together over prolonged periods, profitable rebalancing opportunities may occur infrequently, perhaps once every two or more years.

Therefore, rebalancing at predetermined calendar intervals is not a rational approach. At times, it will produce excessive trading when costs exceed benefits. At other times, profitable opportunities may be missed. No one knows where the stock and bond markets will go—and that’s the point. The occasions and frequency of profitable rebalancing opportunities cannot be predicted reliably.

Determining when and how to rebalance requires careful portfolio supervision. At Cardiff Park, rebalancing is recommended when asset classes move above or below pre-specified boundaries. These boundaries may be defined according to a portfolio’s stock-bond target weights or more appropriately by the percentage drift away from individual asset class target proportions within the stock and bond segments.

While there are good reasons to rebalance, the benefits must outweigh the costs. Several strategies can help minimize the impact:

  • Rebalance with additional cash. Rather than selling over-weighted assets that have appreciated, use cash to buy more under-weighted assets. This reduces transaction costs and the tax consequences of selling assets.

  • Whenever possible, rebalance in the tax-deferred or tax-exempt accounts where capital gains are not realized.

  • Incorporate tax management within taxable accounts, such as cost basis management, strategic loss harvesting, dividend management, gain/loss matching, and similar considerations.

  • Consider implementing an integrated portfolio strategy. Rather than maintaining barriers between asset classes and accounts, manage the portfolio as a whole.

Rebalancing: A Personal Approach

Each client faces a unique rebalancing decision for tax exempt and taxable accounts. In helping our clients rebalance, we base guidance on a structured plan which has been customized according to each investor’s unique blend of goals, risk tolerance, cash flows, and tax status. Sensitivity to deviation from the target allocation, transaction costs, and taxes are taken into consideration.

As rebalancing opportunities arise, we discuss our suggestions via conference calls and email, and always obtain client approval prior to rebalancing.

When recommending security purchases in client accounts, preference is given to purchase additional shares in those funds currently owned, unless we are avoiding wash sales rules, a fund is closed, or we consider a substitute fund to be more appropriate.

Upon request, we will perform tax loss harvesting. We may not recommend rebalancing a specific asset class due to tax concerns, high transaction costs relative to the trade amount, or other reasons.

As individual client circumstances change, so will the analyses, assumptions, and investment management recommendations. Cardiff Park recommends that progress on all financial plans be reviewed at least annually and be thoroughly re-evaluated at least every three to five years.