Did you sell and buy because of market uncertainty?

Read on for strategies and insights into rebalancing your investments.

There is no question that this pandemic affected markets in 2020. With most indexes reclaiming some of the lost ground, many are worried about what the future holds for their portfolio. Whether you are a few years away from beginning to draw down your retirement funds or decades away, the pandemic brought us a couple of market corrections, a bear market, a few bear market rallies, and speculation as to when the next bull market might begin.

How many people looked at their quarterly statements at the end of March this year and decided to sell out of equities and go to cash? Well, for those that did, here is what they missed:

When the second quarter of 2020 closed (the time period from April 1st through June 30th), the Dow Jones Industrial Average turned in its best quarterly performance since 1987. And the S&P 500 turned in its best quarterly performance since 1998.

Investors that sold out of equities back at the end of the first quarter might have been telling themselves that they were “rebalancing.” But they weren’t. They were panic-selling.

Rebalancing Matters

Rebalancing is an exercise that involves selling the investments that have appreciated and buying the assets that have gone down in order to bring your allocations back in line with your original portfolio design. This is not quite as simple as it sounds – it’s as much a science as it is an art.

In golf terms, understanding the science is akin to understanding the physics of why a spinning ball hooks or slices. The art is the execution of the science, such as when you are actually playing golf. It is the execution and follow-through that produces the desired outcome.

Knowing that rebalancing boosts returns is useless unless you – the investor – have the time, discipline, and nerve to follow through and actually strike the ball.

An Investment Advisor Can Help Rebalance

Rebalancing is most effective when it’s hardest to do—selling investments that have appreciated and buying those that have declined. For example, when the S&P 500 hit its low in March 2020, few investors had the discipline to buy more equities at that time. Market behavior often leads people to assume recent trends will continue, but overcoming this bias is crucial.

This is where an investment advisor can add significant value. Even if they only help set an asset allocation and rebalance once a year, an advisor can improve your returns and reduce portfolio volatility. By sticking to a disciplined rebalancing strategy, you’re more likely to meet your long-term financial goals.

While it’s possible to handle rebalancing yourself, many investors struggle with it. Some stick to a buy-and-hold strategy, while others chase short-term gains, often at the wrong time. An advisor can help prevent this mistake, potentially boosting returns.

For those who prefer to rebalance independently, automating the process through features like those available in 401(k) plans can make it easier. If manual rebalancing is necessary, choosing a regular schedule, such as at quarter-ends, ensures you stay consistent without making emotional decisions based on market fluctuations.

However, rebalancing effectively requires having a solid asset allocation plan in place, which many investors lack. Without it, rebalancing may do more harm than good.

Asset Allocation & Rebalancing

Your asset allocation definition matters. Rebalancing works best with non-correlated asset categories, like emerging market stocks and U.S. stocks. If you define your asset classes incorrectly, rebalancing between them may not help.

You should not define your asset class as one industry of the economy. One industry could lose value indefinitely as another industry rises to take its place. Rebalancing into a failing industry only brings your returns down with it.

Meanwhile, you dodge this problem with broader asset class definitions. Information technology, basic materials, and consumer staples are good, broad definitions while candle-makers, diamonds, and leather jackets are too narrowly defined and will fail you.

Further, some sectors are not on the efficient frontier, which identifies portfolios that achieve the highest return and the lowest volatility. Including them in your asset allocation is simply the wrong move. Rebalancing to a poorly designed asset allocation often means moving money from categories that are on or near the efficient frontier into inefficient investments, hurting returns.

Expenses & Taxes Matter Too

There is a great deal to be said about the method of rebalancing. Keeping transaction costs and capital gains taxes low when rebalancing also helps boost your return.

Funds with high expense ratios put a drag on returns too. Even an index fund drops off the efficient frontier when the expense ratio becomes excessive. And it goes without saying but rebalancing into bad mutual funds also hurts your returns.

While the science and art of setting an asset allocation and regularly rebalancing back to it is not an easy discipline, it will help.

Gainplan can teach you the art and the science – and then do both for you.

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