• Nate Baim, MBA, CFP®

Investments: Set It & Forget It? More Like Set It & Check It.


Your Investments: Set it & Forget It? More like set & check it.

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.


Portfolio Risk / Reward Chart

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.



Portfolio Drift Since 2009 Chart

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.



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