Investment Yoga: Breathe Deeply and Rebalance The Portfolio

I enjoy yoga, but my balance isn’t always the best. Just when I think I’m holding my pose, something (usually about 40 pound of 5 year old) comes up and throws me off my center. Sometimes I can adjust my balance, and get back into position. Sometimes I can’t. Onto the floor I go, until I dust myself off and start over. Sometimes I’m laughing, sometimes it hurts. My investments can be a lot like my experiences with yoga. I have my preferred asset allocation, but life and market returns have a way of throwing that allocation out of balance. Then it’s time to rebalance my portfolio. Sometimes I’m laughing, and sometimes it hurts.

Why Rebalance my Portfolio?

Having investments means having some risk. When you start investing, you generally just pick something and put your money in your pick. Maybe you pick an individual stock. Maybe you pick a mutual fund, or a bond fund. As your investments increase, you diversify investments to reduce your risks.

Over time, you run into two issues.

  1. Investment returns differ, and so you get away from your ideal asset allocation over time as some sectors do better than others.
  2. As your life changes, your risk tolerance should change as well. For most people, this means consciously taking less risk as they get older and approach retirement.

This is one reason why target-date funds are attractive. Target-date funds get more conservative the closer you are to reaching the target date. Target-date funds rebalance for you. Robo-advisors like Wealthfront and Betterment rebalance your investments too.  That can be good, because rebalancing is hard.

Rebalancing takes paying attention to your investments. You have to monitor where you are and compare it to where you want to be. It takes a time investment, and it can be difficult to put the time in to monitor your assets and adjust.

Rebalancing can also be difficult for psychological reasons. It’s hard to sell investments that are doing well, particularly to buy investments where the return hasn’t been so great. It can be even harder to sell at a loss. It’s like admitting a mistake. It can feel like losing, and I don’t like to lose.

Rebalancing the portfolio is about minimizing risk, not maximizing the return. If you are going to minimize your risk, you need to check your asset allocation and readjust at least annually. It’s a job that needs doing, and I’ve been dragging my feet.

Why It’s Time to Revisit my Portfolio

I haven’t actually rebalanced my portfolio in a while. I find picking investments that I want to purchase pretty easy. I know what has worked for me in the past, which is investing in high-quality dividend stocks and dividend reinvestment. It’s fun to shop for a winner, and most of my investment activity in the past couple of years has been making sure I was picking good companies for long-term investing.

I also hold some mutual funds and muni bonds. I like the muni bonds for the tax free interest, even though the yield isn’t great right now. Still, between the interest and the tax exemption, they have performed pretty well. With all of the talk about the Fed raising interest rates, though, I haven’t really been enticed to buy more bonds except to replace a maturing bond. That puts my liquid portfolio at about 6% cash, 70% stock and 24% bonds. I’m comfortable with the bond allocation, though it’s riskier than my advisor likes. I do think I could use some more cash. I have just the target for sale, too.

How I’m Rebalancing My Portfolio

I am not satisfied with some of the mutual funds that I am holding. I thought they were good targets for selling, so that I could switch them into investments I like better. I knew if I could hold off on using the bond interest and leave it in the investment accounts, the cash position would eventually improve.

If I could leave it alone. Which I did not do.

I started the process in late spring of 2015, and replaced most of my Roth IRA mutual funds with some stocks I had been looking at for a while. I added some Diageo (DEO) and increased my stake in Reynolds American (RAI), Exxon Mobil (XOM), and Johnson & Johnson (JNJ).

IRAs can be great places for a dividend reinvestment strategy. You don’t have to pay taxes on the dividends, so your investment can grow faster than in a taxable brokerage account. A Roth IRA in particular a good place to take extra risks because of the long term tax-free return.

Last year, I started in on optimizing the brokerage account. I sold a to-remain-nameless mutual fund with a ridiculous expense ratio of over 2% and replaced it with shares of the Vanguard S&P 500 index fund. With some extra cash I was able to buy Admiral shares, with an expense ratio of .05%.

I know, I just said I wanted more cash. I thought the low expense ratio was worth postponing the cash goal a bit. I also knew that this was only the first of several mutual funds to sell, so I figured the cash was still coming.

My timing worked out pretty well on this sale, too. I sold the mutual fund on August 18, right before the big correction. Between waiting for the sale to clear and being on vacation, I didn’t end up buying the Vanguard shares until the 31st. Win!

Okay, it was a completely incidental win. If I’d know the market was going to tank, I would have gotten rid of some other disappointing funds at the same time. I need to sell these other funds, but my plan calls for selling out of one fund at a time. And we went into September, time to sell off another. And if I did it, it would be at a loss.

Selling

A market correction can be a good time to switch out unwanted investments in a brokerage account, because you are minimizing the taxes on capital gains. You can only write off total capital losses of $3000 per year, though. You can carry them over to future years, but you can’t write off the extras unless you have gains to counterbalance them.

But I don’t want to! I don’t want a loss, I want a gain! Especially since one of the reasons to sell the stock is to increase my cash, and cash is giving no return right now.

Okay, I need to slow down and breathe deeply.

Rebalancing is not about maximizing returns, remember. It’s about minimizing risk. And at 70% stocks, my liquid portfolio is too risky.

The key to selling your investments when they are down is to get rid of things that no longer fit your criteria for being good investments. Stick with your strategy. Do I like these mutual funds? No. Would I buy them now? No. Do I think the mutual funds will go back up in price? Yes.

Is that last question about risk and asset allocation? No

Do I need to sell all of them right now to reduce my risk and reach my optimum asset allocation? No.

Breathe deeply. Rebalance.

Can I pick the one I like least? Yes.

Breathe deeply. Rebalance.

Sell.

What financial chores do you find difficult? How do you make your choice to sell investments when necessary? Let us know in the comments?

This article is for information purposes only. I am not a financial professional, only an investor sharing my thoughts. Investors should do lots of research and get advice to determine the optimum asset allocation for their personal situation.

Image courtesy of tiverylucky at FreeDigitalPhotos.net

2 Responses to “Investment Yoga: Breathe Deeply and Rebalance The Portfolio”
  1. RAnn 09/27/2015
    • Emily Jividen 09/27/2015

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