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Rebalancing investments in stormy markets

Professional Businessman Balancing on a Graph Chart: Navigating Complexity

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Credit Sesame discusses rebalancing investments in volatile financial markets.

Wild market swings can make it difficult to know what to do. Risk is amplified. Big market moves are often accompanied by surprising news that can be hard to process. Investors tend to respond by panicking out of fallen investments after the damage is already done or by piling into big winners after the gains have already happened. But the changes can also provide a tremendous opportunity.

Rebalancing is a tried-and-true technique that takes the emotion out of decision-making in volatile markets. It can help you manage risk and capture opportunities.

Given the wild ride the markets have had in recent years, this might be an especially good time to look at rebalancing your portfolio.

What is rebalancing investments?

Rebalancing is a process of putting the mix of investments you own back into alignment. For example, suppose you start with half of your portfolio in stocks and half in bonds. If you had a total of $100,000 invested, you’d have $50,000 in stocks and $50,000 in bonds.

A year later, suppose you find your stocks have dropped in value by 10%, and your bonds have risen by 10%. This would mean you’d now own $45,000 worth of stocks and $55,000 worth of bonds.

As a result of those changes in value, your portfolio would no longer be a 50%/50% stock/bond mix. It would now be 45% stocks and 55% bonds. Rather than let your asset allocation continue to drift, you might decide it was time to reset that allocation based on a conscious decision. There are a couple of ways to approach this.

Reallocating to benchmark

Benchmarks are the targets that investment portfolios aim for. A 50%:50% stock:bond benchmark is a common one. They can also get much more detailed than that, specifying several asset classes and different subgroups within each.

Regardless of how simple or complex your benchmark is, if it reflects your desired level of risk and market participation, you should periodically readjust your holdings to match your benchmark.

Adjusting to conditions

On the other hand, there may be times when you want to deliberately vary from your stated benchmark or your original asset allocation.

This might be because conditions have changed and now call for a different approach. For example, if interest rates have risen sharply, it affects the relative attractiveness of stocks and bonds. You might want to adjust your asset mix accordingly.

In this case, instead of rebalancing to your original benchmark, you rebalance your holdings to match a new asset mix you feel is right for current conditions.

Why is rebalancing effective?

Rebalancing regularly allows you to apply an intentional approach to investing rather than a more random one determined by changes in value over time. This can help you both capture opportunities and manage risk.

Buying low and selling high

Rebalancing to a target allocation is a regimented way of buying low and selling high.

Assets that fall in value become a smaller portion of your portfolio. Rebalancing will prompt you to buy more of those assets while their prices are low. Assets that rise in value faster than the rest of your holdings become a larger portion of your portfolio. Rebalancing will prompt you to trim some of those holdings to lock in gains while prices are high.

Remaining grounded to your goals

Rebalancing also helps you align your investments with your goals and risk tolerance. If you simply let price changes increase or decrease the size of holdings in your portfolio, your investment mix will drift over time.

Instead, you should set targets that reflect your investment goals. Periodic rebalancing will help you stay close to those targets. It also allows you to adjust to changing conditions.

Why rebalance in fall 2023?

Rebalancing is a sound technique under any circumstances, but there are several reasons why now might be an especially good time to take a fresh look at your mix of holdings.

Recent market volatility

The more prices move in one direction or another, the more it creates a need to rebalance. The past few years have seen a pretty wild ride for investment prices.

First, 2020 saw extreme fluctuations just within the space of a few months. The S&P 500 lost 20% in the first quarter of 2020 when the pandemic hit, but then gained a similar amount the very next quarter. It then put together two strong quarters to finish the year up 16.26%.

Stocks then had an outstanding year in 2021, when the S&P 500 gained 26.89%. However, the market followed this with a miserable year in 2022 when the S&P 500 lost 19.44%. The roller coaster ride has continued in 2023. Stocks started the year with strong gains through the end of July but then headed south again in August and September.

All that volatility creates lots of need to rebalance a portfolio. Doing so can often smooth out the extreme ups and downs to some degree. It’s not just stocks that create the need for rebalancing. Investors often use bonds to cushion their portfolios against the volatility of stocks, but the bond market had its own share of drama over those same three years.

Based on the S&P’s U.S. Treasury Bond Index, bonds were up when stocks were down in the first quarter of 2020 but then were more or less flat the rest of the year. They followed that with a poor year in 2021 when the Treasury Bond Index lost 2.12%. Then came an even worst year in 2022, when bonds lost 10.98%.

As with stocks, the volatility has continued in 2023. Bonds got off to a promising start in the first several months but have been fading since the end of May. Again, it’s been a wild ride and often an unpleasant one for investors. Rebalancing can help you keep a sense of direction and even use some volatility to your advantage.

Differences in sector performance

While stocks and bonds had a wild ride in recent years, the experience of individual sectors of the stock market has been even crazier.

While the stock market as a whole was losing 19.44% in 2022, different sectors of the market were taking very different paths. Sector performance ranged from a high of 59.04% for energy to a low of -40.42% for communication services.

These divergent returns create opportunities to realign individual sectors within a portfolio besides rebalancing the mix of asset classes you hold.

Higher interest rates are a game-changer

Finally, fundamental changes in conditions may prompt you to rebalance your investments in light of the new reality. 2022 saw a sharp rise in interest rates, which continued into 2023. Higher interest rates can be a game changer. Higher bond yields may justify a larger bond allocation than when yields were near zero.

You may also want to look cautiously at sectors and individual stocks that rely heavily on continual borrowing. As higher interest rates raise the cost of debt, it will affect some bottom lines more than others.

These are just some examples of how changing conditions may change your target weightings. With investment prices and conditions changing constantly, rebalancing should be a regular part of your investment routine.

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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

Richard Barrington
Financial analyst for Credit Sesame, Richard Barrington earned his Chartered Financial Analyst designation and worked for over thirty years in the financial industry. He graduated from St. John Fisher College and joined Manning & Napier Advisors. He worked his way up to become head of marketing and client service, an owner of the firm and a member of its governing executive committee. He left the investment business in 2006 to become a financial analyst and commentator with a focus on the impact of the economy on personal finances. In that role he has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications.

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