As we discuss how to rebalance to your ideal portfolio allocation for 2018, remember that the most important characteristic of your portfolio — the factor that influences the performance of your portfolio more than any other — is the way you divide your money between asset classes.

An “asset class” is a broad category of investments that tend to have similar risk characteristics and respond similarly to market forces. The most common classes are stocks, bonds, real estate, commodities, and cash equivalents.

SMI’s core strategies approach this asset allocation task quite differently. Dynamic Asset Allocation (DAA) doesn’t require you to choose an allocation, as the strategy shifts the portfolio allocation automatically based on market conditions. (More on DAA in a moment.)

In contrast, the starting point for our two Basic Strategies — Just-the-Basics (JtB) and Fund Upgrading — is to determine how much of your portfolio should be allocated to investments in which you are an owner (stocks) and those where you are a lender (bonds). The more you invest in stocks, the greater the growth potential but also the greater risk.

In determining your stock/bond percentages, it’s important to consider your personal goals and risk tolerance. We’ve provided step-by-step instructions to lead you through this process in the “Start Here” section. At the end of that process, you’ll have stock- and bond-allocation percentages based on your investment “time frame” — that is, how long before you will need to begin withdrawing your money for living expenses.

If you are following Just-the-Basics or Upgrading, you should make any stock/bond allocation changes only in accordance with your long-term plan, and only as a thoughtful response to changes in your circumstances (perhaps your age now puts you in a different “season of life” category) or significant changes in your financial goals or fortunes. Target allocations should not be altered emotionally due to recent activity in the markets. That said, this month’s introduction of a new “safety net” within SMI’s Upgrading strategy (see this month’s cover article) may be significant enough to warrant a review of your overall portfolio allocations.

Note that even without intentional changes in your asset allocation, a well-diversified portfolio is going to gradually stray from its initial allocations as some investments perform better than others over the course of a year. It’s necessary, then, to periodically “rebalance” the portfolio, bringing it back to its target allocations by selling some of the winners and adding money to the laggards.

If you’re a Just-the-Basics investor, rebalance for 2018 simply by adjusting your current holdings to match your desired stocks vs. bonds percentage allocations. (For a step-by-step primer on rebalancing, see Is Your Portfolio Out of Balance? The Just-the-Basics portfolio mix is permanently fixed.)

Simplifying the Upgrading process

If you’re Upgrading, you have an additional step to take. After reaching your overarching stock/bond allocation decision, you have decisions to make about your percentage across the various stock- and bond-risk categories.

In recent years, we’ve been allocating evenly across the stock-risk categories (see table). While we may deviate from this occasionally in the future in response to what we perceive to be unusual opportunities or risks, we expect those instances to be the exception rather than the rule.

This year the rebalancing task for Upgraders is simply to bring their portfolio allocations back to the same starting percentages as last year.

Bonds will continue to be allocated as they have in recent years: Whatever an investor’s overall bond allocation is, half of that is invested in the rotating Upgrading selection (updated monthly at the bottom of the Fund Upgrading Recommendations page), while the other half is divided evenly between short-term and intermediate-term bonds. For example, a person with a 40% total bond allocation would invest 20% in the rotating Bond Upgrading selection, and 10% in each of the Vanguard short-term/intermediate-term index funds (or ETFs).


(Click Table to Enlarge)

Precision not required

Recent research has tended to indicate annual rebalancing isn’t as necessary or helpful as was once believed. SMI still thinks the process is worthwhile, but this body of research has made us less dogmatic about the level of precision it requires. As long as a person is within a few percentage points of his or her long-term allocation targets, that’s probably close enough (especially if there are costs involved in making further trades to get closer to the target allocations).

Rebalancing in DAA

Those with premium memberships also have access to our Dynamic Asset Allocation and Sector Rotation strategies. As we noted earlier, DAA tells you how to allocate as you go.

If you’re following the DAA strategy, you begin by investing one-third of your DAA portfolio in each of three asset classes (represented by three recommended ETFs). Over time, as positions are sold and the proceeds reinvested in different ETFs, your portfolio will lose that equal balance. Your primary rebalancing task is to periodically restore equality to the three positions. But this doesn’t have to happen at the beginning of the year — an imbalance between the three holdings can be addressed any time a holding is being replaced. So feel free to either rebalance your DAA holdings now, or wait until a month when you’ll be making DAA trades anyway.

For those members who are diversifying between strategies, an additional rebalancing task is necessary. For example, someone dividing their investments evenly between DAA and Fund Upgrading may need to rebalance slightly so the same amount is invested in each as we begin 2018. (See A Few More Thoughts On Rebalancing for more on rebalancing a DAA portfolio.)

Wrapping up

We recognize that understanding and applying SMI’s investment strategies has become more complicated over time as we’ve added more options. Many members used to invest their entire portfolio in Upgrading. Now, some have chosen, despite the need for a little added number-crunching, to split their investments between Upgrading and DAA, with many including Sector Rotation as well.

Given this added complexity, we’ve looked for ways to simplify other aspects of maintaining an SMI portfolio. Keeping our Upgrading category allocations consistent from year to year is an example of this effort. While it may not be obvious, so is this month’s cover article topic of bringing potential bear market protection into the Upgrading strategy itself (as opposed to our old Bear Alert guidelines, which were external to the strategy), so all a member has to do is follow the normal Upgrading buy/sell instructions on the Fund Upgrading Recommendations page. It’s our goal to keep things as simple as possible for SMI members, and to that end we’ll continue to look for ways to gain simplicity without sacrificing performance.

If you are an existing member, please Login.