By Robert Cannon, the CEO of Cannon Wealth Solutions.
- The world in 2021 is significantly different after a year of pandemic-related changes in how people live, work, and consume. This has a profound effect on S&P 500 companies and the performance of various asset classes.
- When you do your annual portfolio checkup, you might find that you need to rebalance. Rebalancing your portfolio – buying or selling asset classes to reimpose your portfolio to your original target allocation – is a vital step in controlling and monitoring risk.
- Buying investments in the asset class which is currently out of favor will require you to sell investments from the asset class that is performing well, and will furthermore represent an increased percentage of your portfolio’s overall value.
Robert Cannon, from Cannon Wealth Solutions, will be discussing the need to rebalance portfolios and monitor risk; and although it may seem counterintuitive, you are in fact taking profits from winning asset classes that may have reached their peak and buying other asset classes that have performance potential – in effect, you’re selling high and buying low.
Rebalancing for the Future
Determining your rebalancing strategy will ultimately result in a more consistent level of portfolio risk by buying low and selling high. The purpose of this is to create sustainable long-term value and consistency will help with setting more effective risk and return expectations – a key to maintaining patience under challenging markets. Cannon states that “it is important to rebalance your portfolio because it is essential for matching your tolerance risk as well as your sector concentration which is a form of Credit Risk Concentration”. So, if you are wondering how often you should rebalance your portfolio in order to minimize your risk, then Cannons’ advice would be to do it when your asset class is over 5% or every six months which has also been confirmed by UBS who have also “recommended a fairly simple 5% deviation rule-of-thumb for rebalancing: If the stock/bond component of your portfolio has shifted more than 5% from your target, then rebalance”.
Here are some frequently asked questions about the rebalancing of portfolios, answered by Robert Cannon:
Does portfolio rebalancing actually improve returns?
The rebalancing of portfolios can lower risk and often lower returns.
Is auto rebalancing a good idea?
Yes, auto rebalancing can help reduce risk and can potentially also enhance your returns.
How do you manage rebalancing in a recession and when conducting your simulations, do you also test your model in extreme market conditions?
During a market sell-off, it is usually not a good idea. For example, during extreme market volatility, retirement accounts and taxable investments accounts can quickly drift from the original target allocation as the value of the holdings increases or decreases sharply relative to the rest of your account. Because of this we always test each model in every market condition.
Monitoring Risk for the Future
In order to understand how your investment has performed, you should compare its results to an appropriate benchmark. Cannon reiterates that portfolio risk is measured by checking for the stock standard deviation of the variance of actual returns of the portfolio over time and will then proceed to implement a tactical asset allocation, thus avoiding portfolio volatility. Credit Suisse has also said in conjunction with Robert’s claim that “if the portfolio risk exceeds the risk ability, it can have a far-reaching impact on the assets of those beneficiaries or insured.” The report continues, saying “with a stricter rebalancing approach, investors can better estimate in advance whether their investment strategy will also enable them to survive difficult crises”.
Here are some frequently asked questions about monitoring risk, answered by Robert Cannon:
If rebalancing happens on a regular basis, do you monitor the funds’ performance in between?
Yes, all the time. By practicing a strict approach, investors can better estimate in advance whether their investment strategy will survive tough economic times. With consistent monitoring of funds and a solid rebalancing strategy, it is easier to determine the right size of a reserve or buffer for such negative events than it is using a buy-and-hold strategy. This ultimately will reduce the risk of having to make adjustments in asset allocation in unfavorable markets.
The global pandemic of 2020 has caused investors to adhere and refocus their strategies by consistently their rebalancing portfolios, which have most likely paid off. The key to being successful is by planning for the future, regardless of the fluctuating economic market. Navigating the current investment climate can be very challenging, yet the process of rebalancing is a natural opportunity to switch up your asset allocation if you have not been confident in your original strategy and it is in the hands of your investors to think a few steps ahead to ensure proper action can be taken when current conditions change.
About the contributors:
By Robert Cannon is the CEO of Cannon Wealth Solutions. He has more than a decade of experience in wealth management.
Produced in Association with