Mundane is Good

Amid all that’s going on out there in the world something like rebalancing your portfolio can seem unimportant, even quaint. It’s certainly counterintuitive. But it’s also important because rebalancing keeps your strong performers from growing too large over time and increasing risk in your portfolio. That’s all well and good in theory but how do you do it? What should you choose to sell and when is the right time?

Ideally, you’ll have a threshold around each of your investments of, say, 20%. This means that if a stock fund has a target weighting of 10%, you’d look to trim (not sell entirely) it back once it grows beyond 12%. Having targets like this makes rebalancing easier because it’s something specific to compare to. It also makes the process less subjective and, hopefully, less scary.

But a lot of investors don’t have these targets, perhaps because they’re unsure of how to set them, or maybe because they don’t want to monitor them over time. Assuming this is the case, the next best way to rebalance is to look at the returns of each investment in your portfolio over a particular period. Look at what’s up most year-to-date, over the past 12 months, and perhaps since you bought it. These days brokerage firms have all this data and, if they don’t, you should reach out to them and ask for help with filling any holes.

If you looked at your numbers this week you’d likely see returns like this:

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Mega- and Large-cap stocks are up most YTD, just shy of 20%, and about 33% in the past 12 months. Examples of this are S&P 500-based funds like SPY, VOO, SWPPX, or maybe a total market fund like VTI. All should be great candidates for trimming if you’ve owned them for at least these timeframes.

Big Tech has slowed a bit lately but is still up about 18% YTD and 32% in the past 12 months. NASDAQ-based funds like QQQ have been lagging slightly but have generated almost twice the market return over the past three years. So if you’ve been in QQQ, etc, for at least that long this might be a great opportunity to trim in lieu of an S&P 500 fund alluded to above.

Small-cap stocks are lagging YTD with a return of about 10% but lead over the past 12 months with growth of about 40%. Maybe you hold actively-managed small-cap funds, or perhaps index options like IWM, IJR, and so forth. Small-caps are a tough one because they’ve shown stronger performance coming out of the pandemic but who knows how long the “re-opening trade” might last given recent developments. Also, small-caps have been underperforming for the last 3, 5, and 10 years, so these might be last to trim unless you’re very overweight in this area already.

Mirroring small-caps are the broad foreign markets often held within actively-managed “international” funds and index-based ETFs. This asset class has likely been lagging behind small-caps in your portfolio and would be the last place to trim. You might even add to the sector if your investments are below their target weightings.

As a reminder, taking gains from a stock fund and investing the proceeds into an international fund, or even a bond fund, costs nothing in taxes now if done within your retirement account. It’s all tax deferred until you personally take a withdrawal. This preferential tax treatment of retirement accounts is a beautiful thing when it comes to rebalancing.

Beyond that and echoing what’ve I’ve said before about making gains real, you’ll need to trim back your winners in your brokerage account. This is money that you can choose to add to another investment or withdraw to pay down debt or even invest in yourself. Gains you realize are taxable, so look at your cost basis and determine which lots (your individual purchases over time) might be most advantageous to sell and pick those or go with the typical default choice of “first in, first out” for stock and ETF transactions, and “average cost” for mutual funds. It often pays to be choosy here so, again, your brokerage firm should have this kind of tax-related information on file. If not, call and ask them about it. You can ask about harvesting losses to offset gains as well.

While I don’t intend for these posts to be in any way salesy, I’m compelled to mention that all the above is part of what I do on an ongoing basis for most of my clients. You can do it on your own, or perhaps on your own with help, and there’s definitively a steep learning curve. But it’s important that you find a way that works. It could be a little while yet but we’re nearing a precarious time in the markets when investors start preparing for slower growth and potentially higher interest rates (still lower than historical averages, but higher than we’ve grown accustomed to). That will mean more market volatility and an out-of-whack portfolio will feel it more than anticipated.

Rebalancing like this helps to smooth out your portfolio’s performance and should give you piece of mind as you accumulate for retirement. And it provides some of your spending money when you’re actually retired. So it’s a good habit to get into even though it might feel a little counterintuitive and “small” at times.

Have questions? Ask me. I can help.

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