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Untucked Episode 103

UNTUCKED EPISODE 103

This Coach’s Corner segment covers rebalancing. What is it, how do you do it, and what reservations investors typically have when it’s suggested. You can listen to the segment here or the entire Untucked episode here.

Meghan Tait: [00:00:00] All right, we want to get into coach’s corner. Yeah, let’s do it. Um, so today we are going to talk about rebalancing. We came across a tweet from Charlie Bilello. Um, and his tweet reads, if you held a 60 40 U S stock bond portfolio five years ago, that portfolio is now 75 percent stock, 25 percent bond due to the 100 percent gain in stocks while bonds have been flat is now a good time to rebalance is the way he Positions the the question Um, I think for us what we wanted to discuss today is what is rebalancing?

How does it work? Why do we do it and then because we’ve been having these conversations with clients based on what charlie just shared Um, what are some of the reasons people are struggling with it?

Jeff Mastronardo: Yeah

Meghan Tait: Um, mike, do you maybe want to just? Describe what rebalancing is?

Mike Traynor: Yeah, I mean basically it’s the mix of stocks to bonds The percentages that have, that are set [00:01:00] at, let’s say 60, 40, like you say, um, and the rebalancing takes place when that mix gets out of whack because stocks go up, bonds don’t or vice versa.

And the point of doing it is to, um, in theory you are targeting a specific mix, um, and you want to get back to it because, um, if nothing has changed in your goals, objectives are what you’re trying to accomplish. You should try to keep it as close to that target allocation as, as you can. Um, if you have a balanced portfolio, like you’re, you’re kind of like, you’re not trying to like shoot the lights out with returns.

Like that’s not what you’re doing by setting up like a diversified account.

Jeff Mastronardo: What are you, what are you doing it for?

Mike Traynor: You’re doing it to mitigate, smooth out the ride. Be diversified take advantage of uh, certain asset classes do well others [00:02:00] don’t you want exposure to all of that, um you know a good example, I think is when kovid hit Stocks were down like 30 like immediately.

Yep. Bonds were kind of up a little bit. So everybody’s Everybody’s accounts were instantly out of balance. Let’s say So the rebalance trade there would be to go in and buy stocks Sell bonds, get back to 60, 40 in this example, that was a good thing to do because quickly stocks rebounded. You were, you know, effectively buying stocks cheaply and selling bonds that were expensive.

And that activity over time generally adds value to somebody’s portfolio. And with the added benefit of you’re keeping your, uh, keeping the volatility at a, at a, at a minimum, a lot people let it ride. You know going to 80 20 all of a sudden they go stocks are doing great and Why wouldn’t I just keep it and let it go?

Well, that’s fine [00:03:00] But it’s now a riskier portfolio. It’s a riskier account that you have because stocks are more volatile than bonds and You know when things go south you’re gonna end up getting hurt More so than if you were to rebalance what do you got jeff?

Jeff Mastronardo: I don’t know I mean if you if you have a balanced portfolio, let’s say say 50 50 is that type of portfolio you’re going to need more attention More rebalancing than like a 80 20 80 stock 20 bond

Mike Traynor: What do you mean attention?

Jeff Mastronardo: Like will that get out of whack more frequently because it’s more balanced

Mike Traynor: No, I think I mean the the if you just take stocks to bonds and ignore the underlying like asset classes, right The The getting out of whack is the same because the percentage is the percentage. And

Jeff Mastronardo: what’s the most appropriate time to rebalance?

Like what, right? So if I have a 60 40 portfolio, do I wait till it gets to 70 [00:04:00] 30? Do I wait till it gets to 62 38? Like when do you rebalance? What’s the best time to do that?

Mike Traynor: I think if 5 percent you start to look at it, 10 percent you definitely do. Um, the difference between 60 and 62 is really like nothing.

So, um, and really the difference between 60 and 70 is not enormous, but it starts to get to 75 or 80 or something like that. Then. You just have a totally different portfolio than you started with. And that’s generally not what you’re trying to accomplish. You know, you set it at a certain, uh, percentage for, for specific reasons on how much volatility you’re comfortable with, what you’re trying to achieve.

And if that hasn’t changed, then you have to get back to that. Or you should, you should.

Meghan Tait: And that, that justification, meaning agreed upon, allocation also can apply to that 5 percent deviation rule, agreeing upon a percentage in which we want to evaluate whether or not we should rebalance. [00:05:00] So if things continue to go, you know, positively, we’re not speculating as to whether or not that’s going to continue, or we’re not forecasting or predicting whether it’s not.

We take the, the guessing game out of that decision and just say at X, right, at X percent of deviation we evaluate. So it’s not an end of the year task that we, right, just address in the fourth quarter. It’s as markets move over the course of the year and we get to a point based on an agreed upon threshold, that’s what allows us to make a more of a rules based and less of a feeling based.

I

Mike Traynor: mean, forcing that discipline is important because it’s way harder. To rebalance when stocks go south, right? If all of a sudden you’re you’re you’re 50 50 turns into 35 65 because stocks have cratered most people aren’t like Jumping up and down to buy stocks. They don’t want to do

Jeff Mastronardo: it Yeah that we we’ve received tons of [00:06:00] pushback from clients when those bad markets happen They’re like why would I even think about buying more of that stuff that just went down?

Mike Traynor: Yeah

Jeff Mastronardo: It’s, it’s, it’s amazing because that’s like the basic fundamental rule, right? You want to buy stocks when they’re cheaper and people don’t want to do

Mike Traynor: it. Yeah. And on the reverse, on the other side, stocks are ripping. Why would I sell them? Yeah. Right. It’s the same thing. So, um, but again, like we’re huge believers of forcing, having rules based, um, thresholds so that we’re not trying to look at the.

Political wins or what’s going on in the markets or the, or in, in business or pot, whatever. And. Confusing yourself,

Jeff Mastronardo: thresholds are the, is the only way to do it by setting up target percentages. And when you deviate from that target, that’s when you rebalance, that’s the purest and the best way to do it. A lot of 401k companies will allow people to automatic, like their accounts automatically rebalance either on a [00:07:00] quarterly or semi annually or an annual basis.

But if you’re rebalancing, I guess if you’re not. If you’re going to set it up systematically, that’s better than not doing it. But if it’s an annual rebalance in December and we’re that COVID year, you miss the rebalance in March, right? The market got destroyed in March. You rebalance at the end of March, early April, and then it skyrocketed back up.

And you, you’re rewarded for that. That tactic whereas if you’re doing it based on time whether it be semi annual you’re gonna miss moments where you should be rebalancing

Meghan Tait: so right now We’re experiencing like out performance in equities or in stocks and We’re having these conversations with clients about All of this, why we do it, reinforcing the rules and the discipline that we’ve applied to it, but we’re still kind of met with pushback occasionally.

And some of it we’ve already touched on [00:08:00] specifically things are going well. Why would we deviate from that? Um, but the other one is the tax component. Yep. So when we’re rebalancing, especially when we’re selling assets that are about perform, we’re looking at realizing capital gains and I’m, I guess, specifically talking about Non ira accounts.

Um, how are we navigating these conversations when we believe it’s important for it to be done, but we have to Understand that there’s a a real cost to it.

Jeff Mastronardo: Yeah I mean I have the conversations every day with clients and I mean we just dealt with it and we’re emailing back and forth met with a client last week and Yeah, you’re out of whack and there’s a forty thousand dollar capital gain because we went from like 62 percent stock to 70.

Um, and I’m, I said to the client, look, I recommend you do it. Luckily he had some carry forward losses that can offset some of the gain, but even if he didn’t, like it’s, and I said to him, [00:09:00] cause I didn’t, I forgot that he had the carry forwards. Like if it’s 40, 000 of gain now, and you don’t act on it, then what are you going to do?

You’re going to wait until this account’s 80 20, and the problem’s bigger? So just take little chunks and little bits as, as things go forward. Otherwise you’re going to throw your hands up and say, okay, I’m no longer a 60 40 investor and I’m just going to let this thing rip until it’s almost a hundred percent stock.

And that’s going to be painful.

Meghan Tait: Yeah.

Mike Traynor: Yeah. And then the other piece of it is 2022 when everything was down, we were selling stuff to realize losses, not to change the allocation necessarily, but to bank losses so that. You use those to help rebalance two years later when stuff is, um, when it’s, when it’s in need.

And those are so valuable to have cause then you don’t have to worry about, Oh, I have a 40, 000 capital game. Well, I have 80 grand in losses that I’m going to use to offset and [00:10:00] you know, good to go.

Jeff Mastronardo: Yeah. I mean, I think, um, I think about clients that have, like, some holdover assets that they had, like, before they met us.

Specifically, like, sector funds. Like, the Vanguard Healthcare. It’s like when everything else in the market is doing poorly, and the Vanguard Healthcare fund is doing well. Like, I remember, like, discussions with clients, like, with clients, like, we, we need to, like, we need to sell some of this and carve off some of the gain and and buy some of this other stuff that hasn’t done well.

And they look at me like I’m absolutely crazy. Like everything else is doing terrible. This is doing awesome. Why would I sell this? It just blows my mind how they can’t like it. What is doing awesome right now isn’t going to do awesome forever. Every year it doesn’t work that way, but they don’t remember that.

They don’t remember when the healthcare fund lost [00:11:00] 15 to 20%. Because they’re just thinking about what’s happening right now.

Mike Traynor: Yeah, you’re right. I mean, so many, so many people go through their holdings and they’re like, okay, that’s down, that’s down, sell that, sell that, sell that. And it’s the opposite of what you should be doing.

Unless they’re individual stocks that are, that’s a whole different story. If they’re, if they’re like a legit asset class that you want to own all the time, like you, you do the opposite.

Jeff Mastronardo: Yeah, you just have it gets back to everything that we always talk about with financial planning and investing. I mean, it’s emotional And people are very emotional about their own money if they’re even If they’re even doing this exercise I don’t even know how many individual investors who manage their own money are even doing this looking at assets uh accounts at an asset level and rebalancing to targets, I mean It’s almost impossible to do at vanguard Like their, their trading system is, doesn’t make it easy.

Like it’s [00:12:00] damn near impossible. So I’m curious how people, how like the individual investor does this kind of rebalancing.

Mike Traynor: Most of them that we see just don’t. Yeah.

Jeff Mastronardo: Not to like, I want 20 percent of my portfolio to be in large cap growth. I want 5 percent in small cap and then setting deviations around those.

I mean, I don’t know how you would do that. Is there software that handles that for you? Like a trading software? At like Vanguard or Fidelity?

Mike Traynor: No,

Jeff Mastronardo: no. So you’re just like pen and paper, like figuring out the math.

Meghan Tait: Well, and then to your point, like having to do it by yourself, you’re so less likely to actually pull the trigger.

Yeah. I mean, the conversations we’re having, we’re encouraging people, we’re explaining very thoroughly the tax implications and other implications that may exist. So we’re making the decisions knowing pretty much all of the factors to be able to predict a pretty reasonable outcome. Thank you. Investors on their own do it [00:13:00] yourselfers You think they’re evaluating whether or not the capital gains are going to increase their medicare premiums.

No, like absolutely not. I

Jeff Mastronardo: don’t I I’m, like as we’re talking i’m like thinking like i’m I had this conversation with this client last week and he’s like You email me back. Yeah, like do it rebalance That’s all you had to do. All he had to say was yes or no And then I like email you After I had already figured out like the tax component of it and then Your computer software is going to rebalance this guy’s account perfectly.

He doesn’t have to do anything.

Meghan Tait: Yeah.

Jeff Mastronardo: Like when I help my parents, I go to Vanguard and it takes me like five hours to do the math and do the trading. It’s brutal. Yeah. It’s pretty sweet. All you have to do is say, yeah, go ahead, do it. And then it’s done

Mike Traynor: perfectly. So like market timing is a kind of like a negative.

Phrase in the sense that, you know, market time, you shouldn’t try to time the market. Lots of people do try to time the market, which really means to them, I’m trying to catch this stock or this, you [00:14:00] know, fund at the bottom and sell the top, like all that. And, and it’s typically like they’re looking at economic data or earnings reports or whatever it is.

If you think about it, like rebalancing is actual market timing done, right? Yeah, you can say it that way. Yep.

Meghan Tait: Cool.

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