2022 EP0611 - Planning Matters Radio - Rebalancing

Hey Peter, very good to see you.

I want to ask you an important question and it's because I've been hearing a lot of people around me ask it. Is now a good time to rebalance? And I think a lot of people are wondering because as you and I have talked about at length, the recent market volatility, right? We know that bond yields are falling, stocks are down, so is now a good time to rebalance? Well, I think it's always a good time to rebalance.

Not that you want to do it every day or anything. You don't want to try to time the market with it, but regular rebalancing is one of the fundamental financial principles for long-term success. It helps us in our risk exposure.

It helps us to capture profits when profits are available. There's really three types of rebalancing that should be done with regularity or when it presents an opportunity. So there is strategic rebalancing. That's kind of your regular quarterly rebalancing to make sure that everything stays in alignment as we track along in our financial progress. There's tactical rebalancing. That's kind of as conditions dictate, again, not trying to time the market with this, but when we are seeing momentum shifts, when there is a movement in the market, tactically going in and making sure that our portfolio is not overexposed to risk or that we are capturing gains when they are there, when they're present. And then time optimized rebalancing because we don't want to balance to the same allocation when we are 50 or 60 as we were balancing to when we were 30. We were probably much more aggressive at 30 and maybe at 60 we are rebalancing to a more conservative kind of approach. And that is a shift that evolves over the course of our investment lifespan. And just to kind of explain to everybody watching why this is important.

I always love these visual cues, right, Peter? But this is the effect of not rebalancing. What are we looking at here? Well, if we do rebalance over a period of time over the years, then our risk tolerance matches our risk exposure and that continues to play out over time. The second chart, the chart on the right there shows if we do not rebalance after a run up in the market, we have a much higher exposure to risk and equities. And truthfully, both of these charts should sort of be skewed counterclockwise and kind of facing upward because hopefully the trend is that both of these grow over time, but you don't want the amount of equities and therefore higher exposure to risk and volatility to overtake the portion of your portfolio that you are comfortable seeing risk and volatility with. So since we are facing economic headwinds right now, would you recommend rebalancing toward value, cyclical and international equities?

Well, yes. So the answer is that rebalancing inherently has diversification in mind to where we would be exposed to all of those anyway. We're not rebalancing directly toward one of those. We are rebalancing to include our pre-existing exposure to any of those asset classes because the best performing asset class is almost never the same year after year after year.

It cycles. And so if all we had was tech sector exposure, for instance, we had Apple and Microsoft and Amazon rebalancing our portfolio, if that's all we held, isn't really going to accomplish a whole lot because the three of those generally move in tandem. But if we have some non-correlated asset classes, then rebalancing helps us to capture gains when they are present in one asset class and reposition those gained dollars to an asset class perhaps that is underperforming at the moment so that we can capture when those things swing. All right.

Well, let's talk about that a little bit more in depth then, Peter. As you take a look here at asset classes year to date, oil at the top of the list, of course, I feel that all the time, but also this is when we see bonds and stocks both going down. Is this when we kind of take a closer look at our percentages from 70, 30 and go to 60, 40? Well, I think that what we're seeing here is a little bit of the convergence in rising rates and then supply and demand mixed with the fact that we have necessities, right? So interest rates are rising. You would expect bonds to fall and that's what we're seeing. However, the market volatility that has resulted in that has actually made investors more risk adverse, meaning they don't like the volatility that they're seeing.

So they want to move towards something that is considered more stable or conservative. However, Econ 101, the law of supply and demand, if more people are trying to buy a certain thing, then the pricing does not have to be as attractive. And so as interest rates have risen, we would expect to see bond values fall and we have, stocks and bonds are both down for the year.

But what I think we're seeing is that bonds still are attractive. They're still being purchased as a result of the stock market volatility. And then if you look up at the top of that chart, commodities and oil are things that we are depending on and because of the supply chain issues have had disruptions.

And so again, Econ 101, when there's less of something and yet people are still demanding it, prices rise. Right. Right. Well said.

So I want to ask another question, which is right in your wheelhouse. Are there any tax implications that we should be considering before rebalancing? Yeah, absolutely. We have to understand that buying and selling and trading and rebalancing inside of a qualified account such as an IRA or a 401k does not result in any tax implications because the entirety of the account is tax deferred. That's the beauty. That's the benefit of these retirement accounts. These qualified accounts is that you are deferring any and all taxation on those until you actually withdraw them for income. But that is not the case inside of regular after tax, non-qualified brokerage and investment accounts.

So if instead of investing in my 401k or my IRA, I paid my tax on my money and then brought it home and invested it, that has already been taxed. But the growth on that money still will have tax implications. And that growth is actually realized when there are transactions inside of the account. So the act of rebalancing can actually incur and generate some tax implications. It is something to be aware of. It doesn't say that we negate the necessity of rebalancing because it is going to be important. But you do have to be aware of the potential tax implications when you go to do that. And that's why you should absolutely consult with a qualified experienced financial advisor if you have any questions about that or want to make sure that you understand what those implications will be.

Yeah, so much to consider. I'm glad you said that because this kind of feels like advanced math to me, Peter. So if somebody has some questions to figure out exactly what's right for them, what's the best way to reach you? Yeah, just give us a call.

Nine one nine three zero zero five eight eight six. You can email me Peter at Rishan planning dot com. You can visit the website Rishan planning dot com. It looks like rich on planning dot com.

It's my last name, Rishan. And it is a little bit like advanced math. There are definitely some unknowns within that equation. It's like algebra. You've got to figure out what that unknown variable is.

And a lot of times that unknown variable is taxes. Well, I like that. All right, Peter, thank you. Well, it's always a pleasure.

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