SKARBECK: Rebalancing portfolio not always best option

January 5, 2018

Ken SkarbeckInvestment advisers often advocate a strategy called “rebalancing.” The process of rebalancing realigns the weightings of the various assets in a portfolio.

For example, if your objective is to maintain 70 percent in stocks and 30 percent in bonds, following a year like last year, when stocks far outperformed bonds, those weightings might now be 80 percent stocks and 20 percent bonds. To rebalance the portfolio, the investor would sell 10 percent of his stock position and reinvest the proceeds into bonds, thereby restoring the 70-30 allocation.

The late value investor Benjamin Graham discussed rebalancing in his classic text “The Intelligent Investor.” Graham wrote that a “defensive” investor “should never have less than 25 percent or more than 75 percent of his funds in common stocks, with a consequent inverse range of between 75 percent and 25 percent in bonds.” Market conditions then guide the investor to appropriate allocations. When stocks are highly priced, the investor should sell and move the portfolio closer to 25 percent stocks. When stocks are selling at a discount, the stock percentage should rise toward 75 percent.

Graham distinguishes between two kinds of investors—“defensive” and “enterprising.” He described the defensive (or passive) investor as one who places chief emphasis on the avoidance of serious mistakes or losses. Graham cites the determining trait of enterprising (or active) investors is the willingness to devote time and care to the selection of securities that are both sound and more attractive than the average.

Some advisers recommend clients rebalance their portfolio annually, or even as frequently as quarterly. Other advisers say rebalancing is a judgment call that can vary depending on the client’s goals.

Some investment products and services will automatically rebalance your portfolio. Target-date mutual funds rebalance their portfolios on autopilot. As time passes and the investor ages, the target date portfolio’s “glide path” adjusts the assets toward a more conservative position.

Automatic rebalancing is a key selling feature of investment firms known as robo-advisers, so named for their computer-driven investment process. The firm Betterment’s computers will automatically sell or buy to rebalance your portfolio anytime your chosen asset allocation drifts more than 3 percent.

Thoughtful rebalancing helps investors buy low and sell high, since they are selling some of what performed best and reinvesting in areas that underperformed or are perceived as safer. For Graham’s passive investor, rebalancing offers a way to achieve sufficient results with reduced risk.

Yet for Graham’s enterprising investor, rebalancing is neither ritualistic (annual) nor robotic (automatic). For these investors, business analysis and valuation drive the decision-making process. They pay little attention to rigid asset allocation percentages. When the value of a stock holding gets too overpriced, this investor is on the search for another more undervalued stock, or some other cheaper asset.

In fact, in the current market environment, the enterprising investor would conclude that year-end auto rebalancers are making the mistake of selling highly valued stocks, only to buy even more overpriced bonds. The 30-year bull market in bonds is over, and rising rates will temper future returns. The enterprising investor would opt for holding cash for the short term instead of reinvesting sale proceeds into bonds.•


Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 317-818-7827 or ken@aldebarancapital.com.


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