Did COVID-19 Force You to Wrongly Rebalance?
Overcoming Biases and the Importance of Rebalancing
Your Investment Advisor Can Help You Overcome Biases and Worries
It is without question that COVID-19 has caused untold damage to retirement plans. Whether you were just a year or two away from drawing down your retirement funds or had decades to go, the pandemic brought with it multiple market corrections: a bear market, several bear market rallies, and uncertainty about when the next bull market might emerge.
Many investors looked at their quarterly statements at the end of March 2020 and decided to sell out of equities and move to cash. However, for those who made this decision, here’s what they missed:
By the close of Q2 2020 (April 1st - June 30th), both the S&P 500 and the Dow Jones Industrial Average recorded their best quarterly performance in over a decade.
Understanding Rebalancing
Rebalancing is the process of selling investments that have appreciated and buying assets that have declined, with the goal of restoring the portfolio to its original allocation. While the concept may sound simple, rebalancing requires both scientific understanding and strategic execution.
The science of rebalancing involves understanding how different asset classes move in relation to each other, much like analyzing the physics behind a baseball's spin.
The art of rebalancing comes in executing the strategy effectively, ensuring the portfolio is adjusted at the right times.
Rebalancing is only effective if it is consistently applied. Without follow-through, an investor may miss opportunities to maintain balance and optimize returns.
How an Investment Advisor Can Help
Rebalancing is most beneficial when it feels the most difficult to do. For example, when the S&P 500 bottomed out on March 23, 2020, how many investors were confident enough to buy more equities? Many people naturally assume that recent trends will continue, making it difficult to invest in assets that are currently underperforming.
This is where a financial advisor adds value. An advisor helps:
Set an appropriate asset allocation.
Rebalance regularly and strategically.
Prevent emotion-driven decisions that could lead to losses.
Reduce portfolio volatility while maintaining steady growth.
Even if an advisor does nothing beyond helping to rebalance, it can provide a significant boost compared to a traditional buy-and-hold strategy. Many investors attempt to manage rebalancing themselves, but emotions often interfere with disciplined execution.
Automating Rebalancing
For those managing their own portfolios, automation is a valuable tool. Many 401(k) plans offer automatic rebalancing, which eliminates emotional decision-making and ensures consistency.
If manual rebalancing is required, consider:
Scheduling regular rebalancing at specific intervals (e.g., quarterly, semi-annually).
Avoiding reactionary decisions based on market movements.
Ensuring an asset allocation strategy is in place before rebalancing.
Without a clear allocation plan, rebalancing can be counterproductive.
Asset Allocation & Rebalancing Strategy
Defining asset classes properly is essential for effective rebalancing. It works best when applied to non-correlated asset categories, such as:
U.S. stocks and emerging markets
Bonds and equities
If asset classes are too narrowly defined, rebalancing may not be effective. For example:
Broad categories like technology or consumer goods provide diversification.
Narrow industries like yarn-making or leather jackets carry too much risk and may not recover.
A well-structured asset allocation strategy ensures that rebalancing contributes to growth rather than amplifying losses.
Managing Expenses & Taxes
Rebalancing should be executed strategically to minimize transaction costs and tax implications:
Keeping capital gains taxes low is essential for optimizing returns.
Funds with high expense ratios can negatively impact portfolio efficiency.
Even index funds can become inefficient if fees are excessive.
Rebalancing into poorly managed mutual funds can hurt overall performance.
While the science and art of rebalancing may seem complex, proper execution can significantly enhance investment outcomes. Whether self-managed or professionally guided, a disciplined approach to rebalancing ensures long-term financial stability.