Are you of the philosophy to set it and forget it? Millennials and Gen X love using tech to automate parts of their life. Automating your life is critical, and that can't be any truer with your finances. But, the world changes, and with changes in the broader environment, it is essential to review your financial plan and investment portfolio periodically. The philosophy of setting it and checking it is more appropriate.
Checking in on your portfolio is essential. Working to keep your asset allocation on track to meet your goals is as important as establishing your portfolio in the first place. When managing your portfolio's allocation, you should use several tactics to minimize costs and best control risk.
First, What is Asset Allocation?
Your portfolio includes the cash, bonds, stocks, real estate, and personal assets you own. Each of these represents an asset class. Asset allocation aims to balance your portfolio's potential returns and risk. When managing your portfolio's asset allocation, you are trying to control your portfolio's possible ups and downs (volatility) for the returns you seek. Your financial plan dictates your target asset allocation. Your portfolio should reflect your risk tolerance, capacity, and need.
The chart below shows the historical risk and return profiles of various stock/bond portfolios. For instance, while an all-stock portfolio has the highest return, it also has the most volatility. Selecting the best stock/bond allocation depends on personal characteristics and financial goals.
Each asset within your portfolio has its risk characteristics. For example, cash is not very volatile. Bonds are typically a bit more volatile than cash. And stocks are even more prone to big swings. Given enough time, equities may appreciate or depreciate more than bonds or cash, thus resulting in portfolio drift. Over time the makeup of your portfolio shifts from its target allocation to a new composition that may not align with your financial plan. Regular rebalancing is essential to keep these allocations aligned with your financial goals. The chart below shows an example of portfolio drift.
Maintaining Your Asset Allocation
Portfolio rebalancing ensures that all investments in the portfolio maintain their appropriate weight based on your target asset allocation. As the value of investments increases or decreases, they may get out of sync with your target portfolio weight. Stocks may become a more significant share of your portfolio than you wish. Such a change in your portfolio would likely increase potential returns and volatility. The shift in asset weights can throw off the portfolio's risk profile.
When to Rebalance?
When markets are stable, and your portfolio matches your target allocation, many investors use time as a trigger for when to rebalance. Investors often rebalance their portfolio's strategic asset allocation annually and tactically adjust quarterly.
A strategic shift changes the overall asset classes. An example of a strategic allocation shift would mean moving from riskier stocks to less risky short-duration bonds. A strategic change reflects a modification in your goals. This kind of adjustment significantly changes the risk characteristics of your portfolio. Your financial plan should dictate when these kinds of changes occur.
A tactical change is a shift within asset classes that can vary based on short-term market conditions. A tactical allocation change would be shifting from one kind of long-duration bond to another long-duration bond. The portfolio's objectives don't change with a tactical shift. Market conditions and opportunities often warrant a tactical shift.
When prices move more quickly in both directions, rebalancing an entire portfolio around a time schedule can result in missing opportunities.
Setting Asset Weights
A more adaptable approach determines a preferred weighting for a given asset and rebalances whenever the asset is over or underweight by a pre-set amount. For this approach, you review each investment separately. You will initiate a reallocation if a specific asset class is over or underweight. If the entire portfolio increases, no rebalance would likely occur, assuming the weights between each class remain the same. You can enact this scheme at the strategic or tactical asset allocation level.
Removing Your Emotions – Dollar Cost Averaging
If your portfolio has a large cash balance, or if you have a lump sum to invest, it can make sense to set up a rule that will govern when you purchase assets. This strategy can help you avoid any attempts to time the market.
This strategy is called dollar-cost averaging (DCA), and the implementation is straightforward. To implement DCA, the amount to be invested is divided over a specific period and invested in equal amounts until the allocation is complete. The dollar used to purchase shares does not vary, but the number of shares purchased may change due to price fluctuations. DCA may reduce the investment's cost basis compared to investing all at once. Alternatively, you would be buying less when the assets are expensive.
Tax-Loss Harvesting: Making Lemonade Out of Lemons
Suppose you find your portfolio underperforming. In that case, securities that have experienced a drop in value may still help contribute to your overall financial situation. You can do this by offsetting gains and losses. Selling a security that has lost value and replacing it with a similar one to maintain an asset allocation is called tax-loss harvesting (TLH). Realizing the loss means it can be claimed as a capital loss and directly applied to a capital gain. TLH helps you manage your taxes and potentially lower your tax bill.
The Takeaway
Investing isn't something that should be "set it and forget it." Millennials and Gen X should use technology to automate their finances. But a robot only takes instructions and doesn't think and creatively solve problems due to a changing environment. Managing your asset allocation, implementing a dollar-cost averaging strategy, and deploying tax-loss harvesting are ways to keep your portfolio on track.
Do you need help determining how to manage your portfolio best? Feel free to place a commitment-free 30-minute meeting on my calendar. We can discuss your investments and begin best optimizing your financial plan in that meeting.
Have something on your mind?
This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here.
Pursuit Planning and Investments, LLC (“PPI”) is a registered investment advisor offering advisory services in the State of Oregon and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment advisory services. Any information provided has been obtained from sources considered reliable, but we do not guarantee the accuracy or the completeness of any description of securities, markets or developments mentioned. We may, from time to time, have a position in the securities mentioned and may execute transactions that may not be consistent with this communication's conclusions. Past results do not guarantee future results. Please contact us at 971-803-5948 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions. Additionally, we recommend you compare any account reports from PPI with the account statements from your Custodian. Please notify us if you do not receive statements from your Custodian on at least a quarterly basis. Our current disclosure brochure, Form ADV Part 2, is available for your review upon request, and on our website, www.planyourpursuit.com. This disclosure brochure, or a summary of material changes made, is also provided to our clients on an annual basis.
This communication is for informational purposes only and is not intended as tax, accounting or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement of any company, security, fund, or other securities or non-securities offering. This communication should not be relied upon as the sole factor in an investment making decision.
Past performance is no indication of future results. Investment in securities involves significant risk and has the potential for partial or complete loss of funds invested. It should not be assumed that any recommendations made will be profitable or equal the performance noted in this publication.
The information herein is provided “AS IS” and without warranties of any kind either express or implied. To the fullest extent permissible pursuant to applicable laws, Pursuit Planning and Investments, LLC (referred to as “PPI”) disclaims all warranties, express or implied, including, but not limited to, implied warranties of merchantability, non-infringement, and suitability for a particular purpose.
All opinions and estimates constitute PPI’s judgement as of the date of this communication and are subject to change without notice. PPI does not warrant that the information will be free from error. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. Under no circumstances shall PPI be liable for any direct, indirect, special or consequential damages that result from the use of, or the inability to use, the information provided herein, even if PPI or a PPI authorized representative has been advised of the possibility of such damages. Information contained herein should not be considered a solicitation to buy, an offer to sell, or a recommendation of any security in any jurisdiction where such offer, solicitation, or recommendation would be unlawful or unauthorized.
This work is powered by Seven Group under the Terms of Service and may be a derivative of the original. More information can be found here.