Rebalancing your portfolio once in a while is a simple way to manage investment risk, as SMI's Mark Biller explained yesterday on Faith & Finance. He also discussed how rebalancing increases the likelihood of "buying low and selling high."
To listen, click the play button below. Scroll down for the transcript.
Faith & Finance with host Rob West airs each weekday morning on American Family Radio. A different version airs weekday afternoons on Moody Radio.
(For more radio appearances by members of the SMI team, visit our Resources page.)
Transcript
Rob West:
Question for you: When was the last time you rebalanced your investment portfolio? That long, huh? Well, maybe it's time you did!
I am Rob West. If you're a do-it-yourself investor and not working with a financial advisor, you need to periodically look at "asset allocation." Mark Biller is here today to talk us through the process.
And then it's onto your calls at 800-525-7000. This is Faith & Finance on American Family Radio — biblical wisdom for your financial decisions. (opening music ends)
Mark is, of course, a good friend of ours. He's executive editor at Sound Mind Investing, an underwriter of this program. Once a month, he leaves that corner office and joins us here on the program.
I know it's one of our favorite days, Mark. Great to have you back with us.
Mark Biller:
Well, thank you. Glad to be with you, Rob.
Rob West:
All right, so "portfolio rebalancing," "asset allocation" — these are terms, of course, people hear but don't always know what they mean. So can you share what exactly it means to "allocate" your portfolio — or, for that matter, "rebalance" it?
Mark Biller:
Yeah, those are great questions, Rob. These are foundational investing ideas. But you're right that people don't always know exactly what they mean.
So when we talk about "asset allocation," all we're talking about there is how much of your portfolio gets invested in each type of asset. And the two big asset classes for most people are stocks and bonds. Now, of course, you can branch out into a dozen other things — gold, crypto, real estate, and on and on and on. And there are different types of stocks and different types of bonds.
But for most people, the fundamental asset allocation decision is simply, "How much do I put in stocks and how much do I put in bonds?" And that target allocation becomes your starting point and kind of your benchmark going forward.
Now, when we move over to "portfolio rebalancing," that's just the process of getting your current portfolio back to those target allocations.
And the reason that you have to think about that is that, over time, certain parts of your portfolio are always going to do better than others, so your portfolio is going to gradually drift away from your target or your starting allocation. And this rebalancing process just occasionally brings you back into alignment with that original target.
So, [a] quick example — probably [will] be helpful. If you start with a $100,000 portfolio, and let's just keep it really, really simple: We split that 50/50 between stocks and bonds. Then let's say that stocks have a really good year and they go up 10%, and bonds have a terrible year and they lose 10%.
Well, at the end of the year, you're still going to have the same $100,000 in your portfolio, but your stocks have gone up in value to $55,000. Your bonds have gone down in value to $45,000. So instead of that 50/50 split that you started with, now you have a 55/45 stock/bond split.
So rebalancing would have you take that money out of stocks, put it into bonds to get your allocation back to your original target of 50/50.
Rob West:
So a lot of the initial asset allocation decision really boils down to how much risk you're willing to take, right?
Mark Biller:
Yeah, absolutely. You've got to consider your goals [and] your risk tolerance in determining those original percentages, and how you're going to weight your portfolio between stocks and bonds.
Now, we're usually going to include your age — how long you have until retirement — in that process because someone with a lot of years before they're going to need to draw on their investments can usually take more risk than somebody with a shorter time horizon.
And that whole "risk assessment" process is usually one of the very first things that an advisor or a service like SMI is going to take somebody through in order to arrive at that appropriate asset allocation target. Again, that's your starting point for this whole investing process.
Rob West:
So once a person has an appropriate target asset allocation, that's when we turn to this idea of rebalancing. Explain what an investor gains by rebalancing.
Mark Biller:
Again, it's important that the investor first determines that target allocation really thoughtfully because that's going to be the "plumb line" that we're going to be trying to get back to over and over again. That's kind of the ideal [of] how they should be positioned.
And if they set that correctly, then what it really means if the portfolio moves away from that target is now the portfolio has different level of risk than what the person judged was really the ideal or appropriate amount of risk at the outset.
That's really what this whole thing is all about — keeping your risk level in line with where it ought to be. And so that's really our number one goal and the biggest thing that we get out of rebalancing.
But there is kind of a secondary benefit, and that is that — by occasionally rebalancing — that actually helps us with that ever-elusive goal of trying to "buy low and sell high." It's really difficult for people to do that, but this is kind of a way to automate that.
So if we think about the example we just used, if we're trimming from our stocks after they've gone up a lot and we're putting that money back into bonds after they've gone down, well, that's a subtle way of taking advantage of when the market goes through temporary price spikes and offers us temporary price discounts — because we're naturally going to be doing more of our selling near tops and more of our buying near bottoms if we're following this occasional rebalancing discipline.
Rob West:
And, of course, there's a vivid example of that right now in the markets, isn't there?
Mark Biller:
Yeah, there sure appears to be because all of the big stock market indexes were surprisingly strong last year. They're setting new all-time highs even this week. And at the same time, we've seen bonds just go through one of their worst three-year stretches that we've seen in many decades. So if we take that just at face value, it would seem like this is a pretty good time to be trimming from our stocks when they're near all-time highs and adding money to bonds after a really tough stretch for that asset class. And hopefully in doing that, we're selling high in stocks, we're buying low in bonds.
Of course, with rebalancing, you never really know until later on if prices were actually near highs or lows. But we do know that if we're following this discipline and this is a part of our investing process over many years, well, we're going to tend to be able to take advantage of those opportunities even if we're not always able to recognize them in the moment.
Rob West:
Conventional wisdom seems to be that investors might do this rebalancing once a year, but how exact does it need to be?
Mark Biller:
Yeah, when it comes to rebalancing, this is kind of a "close enough as good enough" kind of a topic — which not everything in investing is that way, but this is. You don't have to do this on a super strict schedule. About once a year is great. A lot of people just automatically do that in January because it's a good reminder to get that done.
And I would also encourage people, Rob, for most people who don't have a lot of different types of assets in their accounts, this is a pretty simple, straightforward process. Most people are just going to log into their company 401(k) account online, they're going to make a few quick calculations and then sell a thing or two here, buy a thing or two here and they're done. So this is not a super difficult thing.
Now it gets a little more complicated if you've got multiple accounts and you've got more diversification into other types of assets. But the main thing is we're just trying to get the account back close to your initial targets. You definitely don't have to sweat this to five decimal points or anything that precise.
Rob West:
Yeah, exactly. And this is, Mark, something an advisor would typically do for you if you're not doing it yourself, right?
Mark Biller:
Yeah, it sure is. This is one of the conveniences of having somebody else handle your investing for you!
There are also some other approaches to rebalancing that can sometimes be a little bit preferable than just automatically doing it once a year the way we're talking about. But for most people, what we're describing today, that's plenty. That's all you need to do.
Rob West:
Let's take some questions. We've got some lines open today for your investing-related questions in this portion of the broadcast. The number to call: 800-525-7000. Your questions for Mark Biller today.
Again: 800-525-7000. You can call right now.
To Wyoming. Hi Russ! Go ahead sir.
Caller:
Hey, good morning gentlemen. So my question is this — and you might have to correct my thinking — but I believe I've heard it said that the [annual] returns from the stock market over the past 50-60 years [have] been around 15%, and over the next 10 years, the perception is they're looking at maybe a 5% or 6% return.
For a guy who's hoping to retire in 10 years, how do you allocate for that? What's the thought there? Am I correct in my thinking?
Rob West:
Yeah, that's a great question. Mark?
Mark Biller:
I probably would adjust those numbers just a little bit. Over the last 10 or so years, we've had higher-than-normal stock returns. But if we look back over several decades, you've pretty much had around a 9% to 10% type of return from the stock market.
And I think probably what you've been hearing, we've talked about it on some of our past programs here as well, is that with stock market valuations being very high today on a historical basis. When we look at some of the ratios and the ways that we measure how richly the market is valued, stocks — they look pretty expensive compared to much of history.
And we also know from stock market history that when you have a starting point where stocks seem expensive like this, future returns tend to be lower than average. So the general idea of your question, Russ, is exactly right — that we very well could be in for a period that has lower stock market returns than are expected.
Now, the first thing I would say is you need to take those types of predictions with kind of a big grain of salt. Because after the financial crisis — coming out of 2008, 2009 — a lot of people were saying we were going to have a slow economy and a slow stock market at that point too. It turned out that was actually a great generational buying opportunity. And we've had very, very strong returns since.
So I would just counsel people — the way that I think you use that type of information appropriately, Russ, is just to understand that stocks may be a little bit higher-risk than usual right now, and so you want to factor that in. But that doesn't mean you want to run from them. You don't want to change everything that you know about investing just because you know might be coming at a high point.
The time that you have to invest is a big part of this, but a lot of times people only measure that until their retirement date. And I would also suggest that, for most people, when they hit retirement, they're probably going to need to keep their investments growing for at least two more decades after that. So if you're in a situation where you're a decade away from retiring and then you're looking at a couple decades beyond that, well you're going to have several more of these bull and bear cycles.
And so I guess the big picture that I would try to convey there, Russ, is probably don't make too much of that information. It's something that you keep in the back of your mind, and maybe it's kind of a fine-tuning piece to maybe adjust your risk a little bit. But for the most part, you want to stick with your long-term asset allocation — like we're talking about today — and someone who's got two or three decades of investing ahead of them needs to still incorporate a decently high stock allocation so that that money can grow and can outperform inflation and keep your purchasing power growing.
Rob, those are my thoughts. Your thinking here?
Rob West:
Well, I think you're spot on, Mark, and I think that was really helpful context for historical returns and why the consensus is we may be in for some lower returns. But don't throw everything out the window just because we don't know what we don't know!
But let me just ask a follow-up question then. So, to take Russ's question to even a more granular level, if the asset allocation for a typical approaching retiree is 60/40 — 60 bonds, 40 stocks — and obviously you need to work with an advisor to determine the appropriate allocation for you, I'm not saying it's a one size fits all. But let's say that was the allocation in light of what you just said about what might be — or likely possible — over the next decade. Would you make any adjustments to that [allocation]? Or would you just stick with what you would've done, let's say, 10 or 20 years ago?
Mark Biller:
Yeah, for an individual doing this on their own — say in their 401(k) — I wouldn't make any adjustments based on this topic. Now, I think where that comes into play, Rob, is more like somebody like SMI that's using some active strategies. We might weight that a little more in our consideration of [whether] we're going to be more aggressive or more conservative. But that's a really difficult game for an individual to play, and I don't encourage them to try to do that.
So I would stick with those long-term allocations. And again, if you've got two or three decades, you're really making the prediction, if you will, that a lot of that is going to "come out in the wash" — and maybe the next five years you are making lower returns, but then you're going to have a period of higher returns at some point down the road that's going to offset that.
Rob West:
Yeah, very good. Russ, thanks for your call, sir. I hope that was helpful to you.
Debra is in Texas. Debra, how can we help?
Caller:
Yes sir. I'm a little bit confused about Roth IRAs with a 401(k) type situation with work. I have a separate one at a bank and I've never been asked about how to — where the funds need to go in the 401(k). They're asking me to choose some mutual funds for that.
Rob West:
Okay, so you have a 401(k), but it's the Roth 401k, is that right?
Caller:
Yes.
Rob West:
Okay. And you're putting money in every month through salary deferral?
Caller:
Yes.
Rob West:
Okay, and they're asking you which mutual funds you want to put the money in, correct?
Caller:
Correct.
Rob West:
Okay, yeah. Mark, how do you counsel somebody just on these options?
Mark Biller:
Yeah, so with both a 401(k) or a Roth IRA, you have the choice of how you want to invest the money once the money is inside that account type.
Now, it could be that at your bank, Debra, they are just automatically making those decisions for you. But it's certainly worth asking them, "What am I actually invested in within the Roth IRA at the bank?" If it's a really low-yielding savings-type product, then you might want to look at that and decide, "Is that really what I want inside this tax-deferred account?"
Because your Roth IRA can be anywhere. You can have a Roth IRA with a broker like Schwab or Fidelity or Vanguard and invest in the exact same types of investments that you are being asked to choose from within your 401(k).
So, certainly, for a younger person who's saving many decades for retirement, I typically would not say that a bank Roth IRA is usually the best choice because they want more growth — they want those stock mutual funds and so forth. Now, it could be that your bank also offers those, so you don't want to automatically assume that you don't want to be there. You just want to ask and find out what your options are.
Because like you said, Debra, if they've never asked you, well, somebody's making that decision of how to invest the money in that Roth IRA, and you need to know that you have a full range of options. Now, maybe you don't at that [specific] bank, but you can move the Roth IRA if you don't like the options being offered to you at the bank.
The biggest thing is — whether it's a Roth IRA or a 401(k) — those are just, that's an account type, that's a "wrapper" on the account, and once you're in the account, you can choose different investments. So it's not like you're investing "in" the Roth IRA. You're putting money in a Roth IRA to invest in whatever it is that you want — stocks, bonds, CDs, and so on.
Does that help Debra?
Caller:
Yes, it does. I just was unclear as to how all that actually worked, and I've tried to look online and really couldn't get a clear answer on that.
Rob West:
Yeah. Mark, let me just ask a follow-up here, specifically related to her 401(k). How do you advise folks? Do you find that the plan administrator can be helpful in her understanding the menu of choices and the best funds for her based on her age and risk tolerance? Does she need to get help from an outside advisor to evaluate those?
If she just doesn't understand what those funds are inside the 401(k), what's her next step?
Mark Biller:
Yeah, I think the first step is usually to check the [401(k) provider] website — see if there's good information there. If that doesn't help, then potentially you might be able to talk to somebody in Human Resources at your own company and see if they have any insight to offer.
And then another option would be a service like we have at SMI. We talk about those types of things at great length across our website, so that could be another option. Of course, if you have an advisor or you want to talk to an advisor, that's certainly right in their wheelhouse as well. So you do have some options there.
And, of course, with the bank IRA, I would just call somebody and talk to them or go into the bank and ask to talk to somebody there about what you have in that account.
Rob West:
Excellent. Debra, thanks for your call today.
Mark, just a few moments left. Give us your take on just what's happening in the market right now. We're in an election year, obviously a lot of headwinds out there, a lot of geopolitical concerns, the jury's still out on what the Fed's going to do, and inflation. And yet it seems like we're hitting new all-time highs every day. Are you surprised by that and what do you make of what's going on right now?
Mark Biller:
Yeah, I am a little surprised, Rob. I think the big surprise for me was that we didn't end up in recession last year. And without the recession, then I think that you have to step back and say that usually, new highs in the stock market tend to be bullish.
Now, the one little caveat on that is we know that a lot of the heavy lifting here is being done by a narrow group of the biggest stocks, and we don't see that same type of strength from the rest of the market — the smaller stocks. What we'd really like to see to say, "Yes, this is a strong market," would be the rest of the market rallying behind those big boys.
So that might be the thing to keep an eye on over the next weeks and months is do the big guys come back to the smaller stocks, which are languishing, or do the smaller stocks start to show a little more strength — which would be very encouraging.
Rob West:
Yeah. Very good. Mark, always appreciate your time, my friend. Thanks for stopping by, answering some questions, and sharing some valuable information. We'll look forward to having you back real soon.
Mark Biller:
Thanks, Rob. Looking forward to it.
Rob West:
All right. That's Mark Biller, executive editor at Sound Mind Investing. If you want some help with your investments, or you just want to learn more about investing through the lens of scripture, go to soundmindinvesting.org and check out the "2024 Rebalancing Guide" while you're there.
Back with your questions on any financial topic. Stick around!
