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The Building Blocks of Sound Investing - Part 4

The Building Blocks of Sound Investing - Part 4

| March 28, 2024

This week we’ll round out our discussion of the building blocks of sound investing with a look at rebalancing. Rebalancing is a crucial component of prudent portfolio management, involving the realignment of asset allocations to maintain desired risk levels and investment objectives. It's akin to tuning an instrument to ensure it produces harmonious melodies, keeping investment portfolios in sync with changing market conditions and your goals, objectives, and risk tolerance.

The process of rebalancing typically begins with setting target asset allocations based on investment goals, risk tolerance, and time horizon. These allocations serve as a blueprint for the portfolio's composition, guiding the distribution of investments across different asset classes, such as stocks, bonds, real estate, and cash equivalents.

As market fluctuations occur and asset values shift, the actual allocation of the portfolio may deviate from these targets. For example, a prolonged bull market in stocks may cause equity holdings to outgrow their intended proportion relative to fixed-income investments. Conversely, a market downturn may lead to a decline in equity values, resulting in an underweighting of stocks in the portfolio.

To bring the portfolio back in line with its target allocations, we use rebalancing. This involves selling assets that have become overweighted and reinvesting the proceeds into underweighted assets, restoring the desired balance. Rebalancing can be conducted periodically, such as annually or semi-annually, or triggered by predetermined thresholds of deviation from target allocations.

The importance of rebalancing lies in its ability to potentially control risk and maintain portfolio integrity. By selling high-performing assets and buying underperforming ones, rebalancing forces investors to sell when asset prices are relatively high and buy when they are relatively low, a disciplined approach that embodies the adage "buy low, sell high."

Moreover, rebalancing ensures that portfolios remain aligned with your risk preferences over time. Without regular rebalancing, your portfolio can become overly concentrated in high-risk assets during bull markets or overly conservative during bear markets, exposing you to unintended levels of risk or missing out on potential returns.

As I said in the first blog of this month, rebalancing is one of the most important parts of my job as an advisor as it is a vital aspect of portfolio management, promoting discipline, risk control, and long-term performance. By periodically realigning asset allocations, investors can navigate market fluctuations with confidence, maintaining financial harmony and staying on course towards their investment objectives.

Join me next month when we will discuss the principles and practices of emotion-free investing, which I consider to be as important as the fundamentals we discussed this month.

Until next time…

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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly. 

All investing involves risk, including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Dollar-cost averaging involves continuous investment in securities regardless of fluctuation in the price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.