Resources/Weekly Insights

Volume 13, Edition 31 | November 23 - November 29, 2024

Rebalancing: An Opportunity to Be Thankful

Doug Walters, CFA

This week we continue our focus on our Guiding Principles with a deep dive into opportunistic rebalancing which can help maintain risk and has the potential to enhance returns over time.

Contributed by Doug Walters, David Lemire, Max Berkovich

We often talk about the importance of smart rebalancing of portfolios. It’s a good soundbite, but perhaps there is more to it than you realize. We have made Opportunistic Rebalancing one of our Guiding Principles because of its dual role in both risk management and potential for return enhancement¹.

The Unsung Hero Controlling Risk

As we continue our series on our Guiding Principles we focus on an unsung hero of portfolio management. Rebalancing plays a critical in keeping accounts in line with your target risk allocation. Let’s say you are an investor with a “Moderate” risk tolerance and have allocated 65% of your portfolio to equities. The riskier elements of your portfolio, like stocks, have a higher expected return (at least they should or why would you own them?). Left to their own devices, your 65% allocation to equities could quickly become 70% or more if stocks have a good run. Before you know it, your risk allocation is no longer Moderate… congratulations, you’ve unwittingly become an “Aggressive” investor.

Rebalancing helps to ensure that does not happen. As stocks outperform, proper rebalancing can lock in those gains by selling a portion and buying other assets in the portfolio to return the allocation to your preferred risk target.

A Potential Benefit to Returns

But evidence shows we can do more with rebalancing than just maintain risk. Enter “Opportunistic Rebalancing.” According to research¹, there is a way to potentially enhance long-term returns with sophisticated rebalancing. There are three key pieces:

Look often: Rebalancing once a quarter or once a year is okay, but you can do better by looking every week to root out opportunities.
Allow drift: Put simply, well-chosen assets need the freedom to outperform over time. We apply wide “corridors” to allow for this.
Be selective: If a corridor is breached, rebalance only those assets that are most out of tolerance, and let the other assets continue to drift.

According to the research, this more nuanced approach to rebalancing can add around 29 bps to performance per year. That may not sound like much, but over a lifetime of investing it can amount to big numbers.

Rebalancing’s Role in 2024

What has rebalancing done for investors in 2024? Its primary role this year has been risk management. With large cap equities up over 25% so far this year, generally our rebalancing has been acting to lock in some of those gains and ensure accounts do not take on too much risk. With that said, our wide corridors have allowed those equities to drift meaningfully so we can take advantage of price momentum without cutting allocation to outperforming securities too much, too soon. Rebalancing is a delicate balancing act between capturing momentum and controlling risk, and that was on full display this year.

We are now more than halfway through our series on Guiding Principles. After Thanksgiving, we will switch our focus to expenses.

1. “Opportunistic Rebalancing: A New Paradigm for Wealth Managers”, Gobind Daryanani CFP^®, Ph.D, Journal of Financial Planning, January 2008

Our Guiding Principles

PATIENCE: Focus on the long-term to fully benefit from market returns.
DIVERSIFICATION: Enjoy the best free lunch in finance.
FACTORS: Identify market segments with a propensity for outperformance.
REBALANCING: Systematically and opportunistically, buy low and sell high.
EXPENSES: Avoid the hidden costs that quietly erode performance.
TAXES: Manage the inevitable burden for successful investors.
BEHAVIOR: Learn to get out of the way of your own worst enemy.

2.8%

Core PCE Inflation for September

The Fed’s preferred measure of inflation (PCE excluding food and energy) was up from 2.7% in August to 2.8%. Including food and energy, was up just 2.3% year on year.

What Investors Should be Thankful for in 2024

Thanksgiving weekend is upon us, and as we do each year, we take a break from our Headlines and Week Ahead to highlight what investors have to be thankful for. In a year that has seen geopolitical hardships abroad and an emotionally taxing election domestically, your investment portfolio has perhaps been a source of many thanks. So, let’s have a bit of fun and dive into them!

Thank you, gold… a second year of strength and near 30% returns over the past year are a nice gift to investors who are also enjoying strong equity performance
Thank you, Momentum factor… you have picked up strong upward equity trends and outperformed the broader market.
Thank you, Federal Reserve… rate cuts have begun, and the stock market has rejoiced. Don’t fight the Fed!
Thank you, artificial intelligence… not only are you making us more efficient at our jobs, but you are a major contributor to strong stock sentiment this year.
Thank you, inflation… you have inched down just enough this year to give the Fed comfort in lowering rates.
Thank you, Small Cap stocks… you’ve come on strong in the past six months, benefiting well-diversified portfolios and reminding investors it’s not always all about the “Magnificent Seven.”
Thank you, fixed income… your returns may not be matching those of equities this year, but they are generally positive while you provide your important role of ballast and risk management.

But most of all…

Thank you to our clients and readers of Insights… we are so thankful to have you as part of our growing Strategic community! We love to hear from you, so please keep the feedback coming in the year ahead.

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on total client assets of over $2 billion.

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