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Not really, but it’s a catchy headline, isn’t it? I ran across an old article about rebalancing portfolios published by Vanguard in 2015, and it piqued my interest. Anytime I read things of a technical nature, I try to figure out an easy way of explaining them. I can talk about standard deviation, correlation, and the various constraints of portfolio rebalancing, but I suspect no one really wants to hear about that, right? When I read this article, I immediately thought of a fairly simple way to think about portfolio rebalancing – a compass. If you asked my wife, she’d tell you I thought of a compass because I have a one-track mind, and some of my college buddies and I just returned from a hiking trip in Grand Teton National Park. While she is undoubtedly correct, I still think the metaphor holds true. Follow along, if you will.

It stands to reason that a 4-day, 3-night backpacking trip would involve some planning and preparation. That’s four days with no electricity, plumbing, kitchens, or any other modern convenience. It also makes sense that a good bit of gear will be needed for a trip like this. However, there is no amount of preparation or gear that can fully prepare you for everything that you may encounter in the backcountry because nature is unpredictable. That’s not to say you just wing it and hope for the best; quite the opposite, in fact. You prepare, and you expect the unexpected. In order to help ensure everyone’s safety and enjoyment, there are three things that are vital to have on the trail:

  • A Plan
  • A Map
  • A Compass

If everything goes according to plan, the weather cooperates, and trails are well marked, you may not use your map and compass all that much. But they are still good to reference when you get to a trail intersection or if you want to know how many more miles you have for the day. On the other hand, if things go badly, they can help you avoid danger, find shelter, or simply get back to a trail that you lost. This is not the sexy gear that you get excited about using – this gear is kind of boring. The technology hasn’t changed in centuries, but it hasn’t had to change because it works. It’s not designed to get you excited to be on the trail, it’s designed to help minimize avoidable risks and keep you on track.

So what could hiking, a map, and a compass possibly have to do with your portfolio? I’m glad you asked.

A Plan

Much like a hike, a portfolio has to be planned. I’ve been planning this trip with my buddies for months and it’s only 6 days from start to finish. Your portfolio is likely going to need to last more than 6 days, so imagine the amount of planning and preparation that should go into it. It will take your entire working life to accumulate and will need to support yourself through your retirement years. You and your advisor have carefully discussed your goals, your fears, and have built a portfolio that is tailored to you and your needs. It is designed to help pursue the returns you need without being subject to undue risk. But just like Mother Nature, the markets are unpredictable. So how do you keep your portfolio on track through both the sunny days and the stormy nights of the markets? You use a map and a compass.

A Map

The map for your portfolio is an Investment Policy Statement (IPS). In addition to laying out expectations of the advisor and the investor, the IPS tells you where your portfolio should be. For example, it will tell you that you are supposed to have 60% stocks and 40% bonds (60/40) in your portfolio. If you were on a trail, “60/40” is the trail where you should be walking. Now as the markets move those numbers will move. Say stocks have a great run like they have over the past 9 years, and your portfolio drifts to 75% stocks and 25% bonds (75/25). The good news is that your portfolio has likely grown, so you’re probably happy, but now with 75% stocks you have more risk in your portfolio than you did when you had only 60% stocks. You may be hiking closer to the edge of the cliff than you’d like to be. You’ve gotten off trail a little bit and need some way to get back. Enter the compass.

A Compass

Just like a compass helps guide us back to the trail, our rebalancing strategy helps us get our 75/25 portfolio back to our desired 60/40. But how do we use that compass? Do we rebalance every time something gets slightly out of balance? If our portfolio goes from 60/40 to 61/39 do we need to rebalance and get back on the trail?

The Vanguard article I mentioned earlier concluded there really isn’t a magic solution for portfolio rebalancing, and the main reason is the purpose of rebalancing. Remember I mentioned that a compass is designed to keep you on track and minimize avoidable risks? The same is true of your rebalancing strategy. It can be tempting to think that it’s part of the overall plan to help enhance return, but the study found that not to be the case. We don’t rebalance portfolios because we are trying to squeeze out extra return; we rebalance them because we want to avoid risk. So when creating a rebalancing strategy, we have to consider how much extra risk we are comfortable taking, and what the cost of avoiding that risk will be.

For most investors, a 5% difference from target weight to actual weight, or one annual rebalance, is a good rebalancing target. With this strategy, you aren’t taking substantially more risk, and with the very real costs to rebalance a portfolio – taxes and trading costs – if you rebalance every time something is slightly off, you would incur unnecessary costs and potentially do more harm than good to the portfolio. That’s the same reason I use a compass instead of GPS when hiking. I could buy an expensive GPS, battery packs, solar chargers, and all that fancy gear so I could be sure with every step I took that I was on the trail, but that’s more cost than I’m willing to incur. I’m willing to chance veering off course slightly, knowing that my trusty $5 compass will get me back to the trail just fine.

And it never hurts to have an experienced guide. While a plan, a map, and a compass are great tools, there is great comfort in having someone who walks these trails daily and is handy at using these tools. Whether it’s a backcountry guide or your Bridgeworth advisor, a guide can help you navigate through the emotionally tough times when fear or greed may tempt you to deviate from your plan.

So remember, whether you are taking a multi-day trip through the Wyoming wilderness or managing a portfolio, never set out without a plan, a map, and a compass. And food, food is important too!

Bridgeworth, LLC is a registered investment advisor.

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This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of April 5, 2018, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Bridgeworth, LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.  Diversification does not ensure against market risk.

Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass.

Reliance upon information in this material is at the sole discretion of the reader.

Investing in stock includes numerous specific risks including the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

Advisor David Ward taking in the view.
Advisors Stephen Gunter and David Ward, and friend.
Advisor Stephen Gunter taking a well-deserved rest.
Advisors Stephen Gunter and David Ward during hike.

Bridgeworth is now a part of Savant Wealth Management as of 11/30/2023. Savant Wealth Management (“Savant”) is an SEC registered investment adviser headquartered in Rockford, Illinois.