Market Overview

Rebalancing act

Are you invested 60% in stocks and 40% in bonds? We doubt it. If that’s all you’re doing to manage your portfolio, you’re probably not reading this.

Investment isn’t a snapshot – it’s a movie. A lot happens between the opening credits and the inevitable fade-to-black, and you need to keep up with the plot.

When to rebalance

Let’s not make things more complicated than they need be and just go with the standard 60/40 allocation. (We’re also including cash equivalents with bonds – again, just to keep it simple.) How much stock is growth-driven and how much is dividend-yielding value shares? What sectors are you holding now, and which do you want to buy into or sell off? And do you tilt more towards mid-caps, large caps or mega-caps?

How much of your fixed-income is in corporate bonds, how much in government bonds and how much in municipal bonds? Oh, and speaking of debt securities: What proportion are in 30-year and what proportion are in 10-year or shorter tenors? (By the way, in the real world, most retail investors never get anywhere near the actual bond market. They buy shares of bond market ETFs that trade like stocks.)

Another way to slice it for both stocks and bonds is geographic: How much of each type of security is tied to the U.S., how much is in other developed economies and how much is in emerging markets? You can even get more micro on your domestic holdings, especially if you’re holding real estate investment trusts or similar instruments.

The nature of the markets is that stocks outperform bonds in the long run. So if you invested $60,000 in stocks and $40,000 in bonds, it won’t be long before your 60/40 split turns into a 75/25 split. Periodically, you might want to sell off some of your equity and buy more fixed income to stay in balance.

Or maybe not. To be honest, this 60/40 convention is just something reasonable that’s easy for both investors and advisors to understand. Your risk preference might indicate that 75/25 is right where you want to be. Alternately, as you age you might become more risk-adverse and 40/60 in favor of bonds might be more appealing.

So clearly, you want to rebalance periodically just because you’re always getting closer to retirement age and your risk profile is likely to change along with your hair color. But that’s not the only reason.

If you just ride the stock market – put the whole equity slice of your portfolio in an S&P 500-tracking ETF and ignore it for 30 years – your investment will increase around 8% adjusted for inflation in a typical year. But when have you ever seen a “typical year”?

So market conditions might encourage you to rotate your holdings. Some industries perform best at the top of the economic cycle, and some are safe harbors during the bottom. Others still flourish before or after the peak.

How to rebalance

You have two options if you decide to reset your allocations. The obvious one is to sell off the securities that don’t fit and use the proceeds to buy ones that do. It’s an effective method, and you can get it done in a day. But should you?

Trading stocks and bonds isn’t as expensive as it once was, but there’s still some friction in the process and still some expense. So you have to ask yourself, “Does it really bother me that I’ve got a lot more large-cap Consumer Discretionary shares than I need and not nearly enough exposure to long-term emerging market bonds?”

If you can still sleep at night, consider changing the composition of your portfolio gradually. You could just stand pat on the asset classes you no longer wish to pursue, then concentrate on acquiring – through the regular course of your investing – those securities in which you’re underweighted.

Catherine Brock recently published an excellent article in Forbes that goes into much more depth.

When to call it quits

Rebalancing over time doesn’t just save you brokerage fees. It can also postpone a taxable event.

“When rebalancing, it’s paramount to pay attention to the type of account your assets are in and the length of time you’ve owned them. These factors will determine how your capital gains or losses are taxed,” according to Giovanny Moreano at Bankrate. “For example, rebalancing your assets in tax-advantaged accounts like a 401(k), IRA, or Roth IRA, will not incur any short- or long-term capital gains taxes. Alternatively, capital gains generated in standard investment accounts are taxable by the U.S. government.”

Let’s not forget, though, that this is a blessing: making so much money in the stock market that the tax man wants to take it away. Still, you’re going to guess wrong on occasion and have to take a loss. That’s where tax-loss harvesting comes in.

This is when you unload securities at a loss, then use the money from the sale to buy similar but not identical securities.

“The loss generates a tax deduction but maintains the portfolio's balance,” according to Jane Adler at Crain’s.

If we lost you anywhere along the way while discussing this subject, we apologize. Bear in mind that we did our best to keep it simple. But it isn’t simple. It requires expertise on the part of an experienced financial professional as well as discipline and good habits on your own part. Maybe it’s time for both of you to meet to discuss how and when to rebalance your portfolio.

Yet another note on Boeing

Four months later, and Boeing is still making more news than a healthy company should make.

First, at this newsletter’s deadline Boeing had reportedly come to a plea deal with the U.S. Justice Department. The company will plead guilty to a fraud conspiracy charge and pay $243.6 million in fines. This is related to two incidents in which 737 MAX jets crashed, killing a total of 346 people.

And as for those astronauts who flew Boeing’s Starliner spacecraft to the International Space Station? As of this writing, they’re still there because of issues with the vessel’s thrusters. It is now Day 36 of their nine-day mission, although NASA is quite keen not to describe the pair as “stranded”. But how do you describe yourself if you’re stuck in St. Louis overnight?

You might look at a company like this and say, “Wow, the wheels are really coming off!” You’d mean it figuratively, but in Boeing’s case …