Did COVID-19 Force You to Wrongly Rebalance?

contemplating a balance on scale

Your investment advisor can help you overcome your biases and worries

It is without question that COVID-19 has caused untold damage to your retirement plan. Whether you were as close as a year or two away from starting to draw down your retirement funds or had decades to go, to COVID-19 pandemic brought a couple of market corrections with it: a bear market, a few bear market rallies, and the question of when the next bull market might be.

How many looked at their quarterly statements at the end of March 2020 and decided to sell out of equities and go to cash? For those who did, this is what was missed:

  • When the second quarter of 2020 closes (the period of the year beginning April 1st to June 30th) the S&P 500 as well as the Dow Jones Industrial Average are both set to have their best quarterly performance in over 10 years.

Those investors who sold out of equities at the end of the first quarter probably did so as ‘rebalancing,’ but that was not what they were doing. Rebalancing is an entirely different concept; they were panic-selling.

Rebalancing Matters

Rebalancing is when an investor sells the investments that have appreciated and buying assets that have gone down with the meaning to bring your allocations back in line with the investor’s original portfolio. The act of rebalancing is more complex than it sounds on paper; It is as much a science as it is an art.

Understanding the science of it is similar to understanding the physics behind the spin of a baseball after it leaves the pitcher’s hand. The art is the execution of the science like when you are actually pitching a game of baseball. The execution of the rebalancing and the follow-through of it is what produces the desired outcome for the investor. Rebalancing is useless unless the investor puts the energy and follow through into it.

An Investment Advisor Can Help Rebalance

Rebalancing is the most useful to an investor when it is the most difficult to do. As a reminder, rebalancing is when the investor sells the investments that have appreciated and buys the assets that have gone down recently.

Going back to when the S&P 5oo bottomed out on March 23rd, how many investors were ready to buy more U.S. equities when the first quarter came to an end? Most people are biased to believe that recent market trends will continue, but when it comes to the market, this instinct must be overcome.

This is where an investment advisor can add great value to you. Even if the advisor does nothing but help to set an asset allocation for you then rebalance manually has the potential to boost your returns over a buy and hold strategy. The act of rebalancing can lower the volatility of your portfolio, so putting these together can increase the likelihood of you reaching your retirement goals. This could be done by yourself, but for a good reason, many investors don’t. A portion of investors buy and hold investments while a greater portion chase returns, so even if the advisor keeps you from chasing past performance could boost your returns significantly.

If you do choose to rebalance yourself then you can accomplish the task more easily by automating your rebalancing which is most common in 401 (k) accounts. If you are required to choose certain months or days to rebalances, then consider quarter-ends.

It is important to ensure your portfolio is being rebalanced regularly. If your only available option is to rebalance manually, then the danger of emotionally picking the point to rebalance is present. To avoid this, the investor should pick times of the year blindly and stick with it. With this being said, to receive a rebalancing bonus the investor must have an asset allocation plan in place which most do not have.

Asset Allocation & Rebalancing

Your asset allocation definition is important. Rebalancing works best with non-correlated asset categories such as market stocks that are emerging and U.S. stocks. If your asset classes are defined incorrectly then rebalancing between them may not help.  You should not define your asset classes as one industry of the economy because one industry could lose its value indefinitely while another industry climbs to takes its place. Rebalancing in a falling industry only lets your returns fall as well.

This issue can be avoided with broader asset class definitions. Information tech, basic materials, are good and broad definitions, while yarn-making, rhinestone and leather jackets are defined too narrowly and will fail you.

Expenses & Taxes Also Matter

There is much to be said in regards to the method of rebalancing. Keeping transaction costs and capital gains taxes down while rebalancing helps to boost your return. Funds with a high expense ratio can also put a drag on returns. Even an index fund drops off the efficient frontier when the expense ratio becomes too excessive. It does not need to be said, but rebalancing into a bad mutual fund will also hurt your returns.

While the art of science of asset allocation and regularly rebalancing your portfolios not easy, It will help. Let the professionals at NEST Financial teach you the art and the sciences, then let them do both for you.

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