Two of my favorite lifetime pursuits are: (1) matching wits with brown trout on local streams, and (2) seeing clients reach their financial goals.

For both, patience is key. It requires stealth and a disciplined process to fool a brown trout, who has evolved through eons to be wary of predators. Achieving investment goals to fund one’s financial dreams also requires a disciplined process. The cornerstone of that process is called rebalancing.

Much like fly fishing, the idea of rebalancing is easy enough. But in practice, it can be harder than you’d think. Two steps can help you succeed.

Step 1: Start with a Plan

Imagine it’s your first day as an investor. As you build your shiny new portfolio, you and your advisor decide how much weight you want to give to each type of investment, or asset class. So much to stocks, so much to bonds … etc.

Why not just pick a bunch of securities with stellar track records? Because, as a discipline, investing isn’t about chasing past performance. It’s about hoping to capture future returns by:

  • Investing in a broad swath of stock market risk factors (along with their expected premium returns); and

  • Reducing the risks with a measure of more stable (but lower-returning) bonds.

That’s what your plan is for: to define your portfolio’s ideal risk/reward mix. Then, you must stick to your plan over time. That’s where rebalancing comes in.

Step 2: Stick to Your Plan Through Rebalancing

Let’s say your plan calls for investing half your portfolio in stocks and half in bonds, for a 50%/50% mix. So far, so good. But there’s a catch (no pun intended): over time, market forces shift those percentages around.

For example, most recently, stocks have been shooting out the lights, while bonds have been plodding along. Even if you’ve been out fishing all year and never touched your portfolio, your 50/50 stock/bond balance may now be closer to a 60/40 mix. As a result, you’re now exposed to more investment risk than you planned for.

To get back on plan, you rebalance by selling some of your top-heavy stocks and using the proceeds to buy underweighted bonds. Rebalancing accomplishes two goals:

  • It shifts your assets back to plan (closer to a 50/50 mix in our illustration).

  • It instills the discipline to consistently buy low and sell high.

A stock/bond portfolio is admittedly an overly simplified example. Most portfolios contain a mix of sub-asset classes like domestic and international stocks, growth and value stocks, large and small stocks etc. Rebalancing among sub-asset classes is also important.

What’s So Hard About Rebalancing?

Of course, every investor hopes to buy low and sell high; rebalancing is just another way to describe that admirable act. So why don’t more investors regularly rebalance? Because emotions often get in the way of our rational plans.

Think about how it feels while markets are surging. Lately, it seems everyone except you is seizing the day. At best, you manage to stick to what you’ve got. More likely, you’re tempted to get in on the action yourself. The last thing you’re inclined to do is to rebalance, by selling some of your high-flying stocks to buy more boring old bonds.

Conversely, when markets tank, fear dominates—like in February 2020. When the pandemic hit, many assumed the markets would be nothing but doom and gloom for months or years to come. To rebalance, you would have needed to sell out of comforting bonds and buy into scary stocks. How many had what it took to achieve that “simple” goal?

The Power of Planning

In short, whether markets are rising or falling, rebalancing means selling recently winning assets and buying the recent underdogs (and doing so as cost-effectively as possible). Even if that’s the same thing as buying low and selling high, it’s hard to do. It demands patience and stamina.

How do you succeed at it? Circle back to our two simple, but challenging steps. First, create a personalized investment plan to guide you through the market’s changeable moods. Then, be disciplined about periodically rebalancing back to your plan—come what may in the markets.

A Taxing Subject

By the way, just like in fly fishing, there are several nuances to rebalancing—including the impact of taxes and trading costs. These days, trading costs are low. But, while we can sometimes employ tax-loss harvesting and other strategies to offset the impact of taxes, they can remain a major factor when determining when and how to effectively rebalance.

At Modera, we strive to simplify these and other complexities by helping families like yours invest according to solid, evidence-based investment strategies. Would you like to know more?  While many of you are most likely familiar with the concepts and practice of rebalancing, we invite you to get in touch with us to continue the conversation.

Modera Wealth Management, LLC (“Modera”) is an SEC-registered investment advisor with places of business in Massachusetts, New Jersey, Pennsylvania, North Carolina, Georgia and Florida. Modera may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. SEC registration does not imply any level of skill or training.  For information pertaining to our registration status, fees and services, please contact us or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov) to obtain a copy of our disclosure statement set forth in Form ADV Part 2A. Please read the disclosure statement carefully before you invest or send money.

This article is limited to the dissemination of general information about Modera’s investment advisory and financial planning services that is not suitable for everyone. Nothing herein should be interpreted or construed as investment advice nor as legal, tax or accounting advice nor as personalized financial planning, tax planning or wealth management advice. For legal, tax and accounting-related matters, we recommend you seek the advice of a qualified attorney or accountant. This article is not a substitute for personalized investment or financial planning from Modera. There is no guarantee that the views and opinions expressed herein will come to pass, and the information herein should not be considered a solicitation to engage in a particular investment or financial planning strategy. The statements, information and opinions expressed in this article are subject to change without notice.

Investing in the markets involves gains and losses and may not be suitable for all investors and should not be considered a solicitation to buy or sell any security or to engage in a particular investment or financial planning strategy. Individual client asset allocations and investment strategies differ based on varying degrees of diversification and other factors. Diversification does not guarantee a profit or guarantee against a loss.