The Rebalancing Act: Long-Term Returns and Volatility
In the current financial crisis, investors’ patience is being tested. There is no way to predict when we’ll reach market bottoms or how long recovery will take. Frustrating though the answer is, the appropriate action for most investors right now is to stay the course with their strategy already in place prior to the crisis. This “inaction” is especially true for CornerCap Wealth Advisors’ clients, whose risk profiles and portfolios were appropriately calibrated for this volatile period.
At the same time, our team of advisors is taking proactive steps to position clients for the forthcoming recovery, such as by helping them capitalize on the unique tax efficiencies opened up by the passage of the CARES Act.
Another step we are taking on clients’ behalf offers investors an important opportunity to compound and, in turn, potentially boost returns on investments: rebalancing.
CornerCap Wealth Advisors build highly diversified multi-asset class portfolios for clients upfront, then systematically rebalance them as needed over time to stay diversified and avoid concentrated positions. Our disciplined approach yields a diversified portfolio that lowers volatility and downside risk, which is especially important during the unpredictable market conditions we’re currently facing.
Think of rebalancing as a contrarian trading strategy in which you sell assets after they have outperformed and buy assets after they have underperformed. Seem counterintuitive?
Despite what you might think, it isn’t. In fact, history has demonstrated how rebalancing can improve chances of creating incremental return on investment portfolios over time.
Striking a Balance between Risk and Reward
Asset allocation is about balancing risk and reward. Invariably, some asset classes in your portfolio will perform better than others. This can cause your portfolio to skew towards an allocation that takes too much or too little risk based on long-term investment objectives.
Let’s say your target allocation was originally 70% stocks and 30% bonds. A stock market rally might leave your portfolio at 80% stocks and 20% bonds. This allocation is great if the market continues to go higher, but if there’s a sharp correction, you likely will see a more severe decline in your portfolio.
Selling a portion of your winning stocks and putting that money back into asset classes that have underperformed may not seem like a great strategy on the surface, but stock market history is filled with examples of outperforming asset classes turning on a dime. Investors heavy in tech stocks found this out the hard way when the Dot Com bubble burst in early 2000.
Why Rebalancing Matters
Rebalancing enforces a level of discipline ideal for weathering changes in market leadership over time successfully. It can be tempting to let top performing holdings and asset classes run when the markets seem to keep going up, but this is how markets become concentrated.
Simply put: a diversified portfolio lowers volatility and downside risk.
Rebalancing is necessary if you’re looking for the best chance of compounding and, in turn, boosting returns on the investments you make.