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  • Milad Taghehchian, CPA, CFP(R)

Why and When to Rebalance

What is rebalancing?

Rebalancing is a smart way to control your risks in investing. It realigns your portfolio back to its original asset allocation. The rebalancing process consists of selling what has become a larger piece of the portfolio than you originally intended and buying what has shrunk to become a lower percentage than your target allocation called for. The idea here is that your original asset class ratios were designed based on historical risk and return expectations to fit your particular goal. If left untouched the portfolio grows in ways that naturally will shift the percentages away from the original intention causing the risk, return, and correlation characteristics to drift away from the target desired.

When to rebalance?

At Pioneer Wealth, we rebalance your portfolio dynamically. We call this timely rebalancing. Any time any asset class in your portfolio drifts to be 15% higher or lower than its initial target, we immediately buy or sell to rebalance that particular asset class. For example, if our original intention was to have 20% of your portfolio in large us companies and we are now at 23% then we need to scale back our large us holdings. This also naturally means that some piece of the portfolio is now less than our original targets. This is the portion we would be buying into with the proceeds of the sale. Research shows this drift form of rebalancing is much more effective than just saying you will rebalance on a specified date such as every 6 months. A very important key in adding efficiency to your portfolio is doing the rebalance when statistically necessary not on some arbitrary date.

Additionally, every time you receive a dividend or deposit more money, Pioneer Wealth will invest it into the part of the portfolio that needs more funds. This can negate the need to sell often to rebalance which creates much higher levels of efficiency from a tax and transaction cost standpoint.

Taking Human Nature Out of the Equation.

Setting these target asset class percentages accompanied by a acceptable amount of drift (15% in our case) and creating rules around when to buy and sell various asset classes prevents you from making the all too common behavioral mistakes that come with reacting to markets and the 24/7 news networks need to create drama. Emotional reaction to news and markets is THE most common reason people end up with inefficient portfolio returns over long periods of time. For example, many people in the weeks leading up to and coming out of the November 2016 US Presidential elections liquidated large pieces of their portfolio out of fear of the unknown that comes from any changing of administration. From Novermber 2016 until May 15 2018, these folks missed out on about 30% return in the S&P 500. Its difficult for anyone to predict what markets will do. Sticking with an investment plan and tweaking the plan along the way is the only way to create long term efficient results.

Talk to your financial professionals about how best to take advantage of a rebalancing process that allows for a drift. Make sure that the rebalance is only occurring when required not on some arbitrary date.

As always check with your financial professionals about how this information can benefit your particular situation.

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