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Portfolio Rebalancing – Halftime 2024

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Halftime 2024 – Portfolio Rebalancing

As we hit the halfway mark of 2024, and the stock market is near all-time highs, it’s a perfect time to review your investment portfolio. Just like a football coach adjusts strategies based on first-half performance, now it’s time to assess your strategy and make adjustments, like rebalancing your portfolio, to ensure a strong finish.

Why Rebalance?

Rebalancing is the process of realigning the weightings of your portfolio assets to maintain your desired level of risk and return. Here’s why it’s important:

  1. Maintaining Risk Tolerance: Your original asset allocation was chosen based on your risk tolerance, time horizon, and investment goals. As some assets outperform and others underperform, your portfolio’s risk profile can change, potentially becoming more aggressive or conservative than intended.
  2. Locking in Gains: By selling high-performing assets and buying underperforming ones, you can lock in gains and potentially buy low, setting yourself up for future growth.
  3. Discipline: Rebalancing enforces a disciplined approach to investing, helping you avoid emotional decisions based on market fluctuations.

Guide to Rebalancing

Halftime Analysis

Like players reviewing game videos, examine how each of your investments has performed. Large-cap stocks have been the clear winner so far in 2024, gaining just over 15% in the first half of the year. International stocks picked up a little more than 5%, while even keeping your cash in a money market fund earned you 2.5%. On the other hand, small cap stocks or bonds went essentially nowhere unless you were in a good actively managed small cap fund. As a result, your portfolio may not resemble your target asset allocation.

Review Your Target Allocation

Next, revisit your target asset allocation. This is the mix of stocks, bonds, cash, and other investments that align with your risk tolerance and financial goals. In my case, I aim for a portfolio composed of 50% stocks, 30% bonds, and 20% alternatives and cash. Your targets may be significantly different.

Assess Current Allocation

Calculate the current allocation of your portfolio. Given the market movements in the first half of 2024, your portfolio might look different from your target. Large Cap stocks may now represent a larger portion of your portfolio than intended, while Small Caps and Bonds may be underrepresented.

Identify Overweight and Underweight Assets

Compare your current allocation to your target allocation. Identify which assets are overweight (more than your target) and which are underweight (less than your target).

Choose a Rebalancing Strategy

Decide on your rebalancing approach. There are a few strategies you can use:

  1. Calendar-Based Rebalancing: Rebalance at regular intervals, such as quarterly or annually. This approach is simple and ensures you regularly check your portfolio.
  2. Threshold-Based Rebalancing: Rebalance whenever an asset class drifts from its target allocation by a certain percentage, such as 5%. This approach is more dynamic and responsive to market conditions.
  3. Dynamic Rebalancing: During the Financial Crisis of 2008 I developed an approach I call Dynamic Rebalancing. It is like having real-time analytics on the sidelines, constantly assessing market conditions and suggesting when to call certain plays. It’s been used by institutional clients since then, but I’ll be making it available to subscribers once my newsletter gains some traction.

Here’s why you might choose this approach:

  • When to Rebalance: Dynamic rebalancing leverages market momentum, capturing larger returns as the market moves between bull and bear phases.
  • Flexibility: It uses the mean reversion nature of market cycles to determine when and how much to rebalance.
  • How Much to Rebalance: It uses the strength of market moves to enhance the probability of achieving greater returns, allowing for over and underweighting in addition to rebalancing “to target.”
  • Effectiveness: Dynamic rebalancing is particularly effective for signaling when to rebalance between stocks and bonds. It can even be helpful within asset classes, such as between large-cap and small-cap stocks. It reviews asset class-specific trends monthly and takes action on “outlier” signals, reducing turnover with trades typically occurring from 6 months to 2 years apart.

Executing Portfolio Rebalancing

To rebalance, you’ll typically need to sell portions of overweight assets and buy more of the underweight ones. Here’s how you might adjust based on our mid-2024 scenario:

  • Sell: Reduce your holdings in large-cap stocks which have significantly outperformed.
  • Buy: Use the proceeds to Increase your investments in small-cap stocks, bonds, and perhaps international stocks which have all underperformed relative to large-cap stocks.

Consider Transaction Costs and Taxes

Before making any trades, consider the transaction costs and tax implications. In tax-advantaged accounts like IRAs or 401(k)s, you can rebalance without worrying about capital gains taxes. In taxable accounts, be mindful of the tax impact of selling investments. Only consider selling investments in a taxable account that you have held for a year or more to avoid higher short-term capital gains tax.

Monitor and Adjust

After rebalancing, continue to monitor your portfolio. The market will keep changing, and your portfolio should stay aligned with your long-term goals. Set reminders to review your portfolio regularly and be ready to make adjustments as needed due to changes in the financial markets or even your long-term financial goals.

Why Portfolio Rebalancing Now?

With stocks at all-time highs, now may be an opportune time to rebalance. Here’s why:

  1. Capture Gains: Selling high-performing assets like large-cap stocks allows you to lock in gains and protect your portfolio from potential downturns. It’s like protecting a lead in football – sometimes the best offense is a good defense.
  2. Risk Management: Rebalancing helps ensure that your portfolio’s risk profile remains aligned with your tolerance. With large-cap stocks up significantly, your portfolio might be riskier than you intend.
  3. Opportunity: Underperforming assets like small-cap stocks may offer buying opportunities. By rebalancing, you can buy these assets at lower prices, positioning yourself for future growth.

Conclusion: Keep Your Portfolio in Top Shape

Rebalancing is a vital part of maintaining a healthy investment portfolio. By taking a disciplined approach and regularly adjusting your asset mix, you can keep your portfolio aligned with your risk tolerance and financial goals. As we reach the halfway mark of 2024, consider taking a closer look at your investments, making necessary adjustments, and ensuring that your retirement savings are on track. Just like a coach making strategic changes at halftime, your proactive steps now can set you up for success in the second half of the year and beyond.

Retirement Investing Playbook

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Your Retirement Investing Playbook

Introduction: Why You Need a Retirement Investing Playbook

Just like any sports team needs a solid game plan to win, your financial future requires a strategic retirement investing playbook. Without one, you might find yourself scrambling when you should be cruising comfortably into retirement. Let’s dive into how you can set up a retirement investing playbook that ensures you stay on track and score the ultimate goal: a fun-filled and secure retirement.

Setting Goals: Your Roadmap to Success

Every winning team starts with a clear objective, and your retirement strategy is no different. You have probably heard this before, but it’s worth repeating: Setting specific, measurable, achievable, relevant, and time-bound (SMART) goals gives you a roadmap for your financial journey. Do you want to travel the world, buy a beach house, or simply ensure a comfortable lifestyle without financial stress? Clearly defining what you want will guide your investment decisions and help keep you motivated along the way. Remember, if you don’t know where you’re going, you’ll never get there.

Understanding Risk Tolerance: Know Your Limits

In sports, a good coach knows the strengths and weaknesses of their team. Similarly, you need to understand your risk tolerance – how much market volatility you can stomach without losing sleep. Are you a risk-taker, like a golfer shooting for the green over water, or taking the more conservative approach of laying up in front of the hazard? Assessing your risk tolerance involves looking at your financial situation, investment experience, and psychological comfort with potential losses. This self-awareness ensures that your investment strategy aligns with your personal comfort level and long-term goals.

Creating a Diversified Investment Portfolio: Spread the Risk

No successful team relies on just one star player. Diversification – spreading your investments across different asset classes like stocks, bonds, real estate, and alternatives – is key. This strategy reduces risk because when one asset class under performs, others may perform well, balancing out your overall returns. Think of it like a football team: you need a strong offense, a reliable defense, and special teams to cover all scenarios. By diversifying, you’re not putting all your eggs in one basket, which helps protect your retirement savings from market ups and downs.

Asset Allocation: Balancing the Team

Your asset allocation is how you divide your investments among different asset classes, tailored to your risk tolerance and retirement goals. It’s like choosing the right mix of players for your team’s lineup. Younger investors might lean towards a more aggressive allocation with a higher percentage in stocks, seeking growth, while those closer to retirement might favor bonds and other more stable investments. The right asset allocation can maximize returns while minimizing risk, ensuring your portfolio supports your retirement objectives.

Dynamic Rebalancing: Staying on Track

Even the best game plan needs adjustments as the game progresses. Rebalancing is the practice of periodically reviewing and adjusting your portfolio to maintain your desired asset allocation. Over time, market movements can shift your portfolio’s balance, potentially exposing you to more risk than you intended. By rebalancing, you’re selling high-performing assets and buying underperforming ones, maintaining your original strategy. It’s like making halftime adjustments to ensure you’re still on course to win. Dynamic Rebalancing is my approach to making this important decision.

Conclusion: Preparing for Victory

Setting up your retirement playbook involves careful planning, goal setting, understanding your risk tolerance, creating a diversified portfolio, and maintaining your strategy through Dynamic Rebalancing. By following these steps, you’re laying down a strong foundation for a secure and enjoyable retirement. Just like a well-coached team, your financial future will be ready to face any challenges, ensuring you can enjoy your golden years without financial stress.

Remember, the key to winning the retirement game is not just about how much you save, but how smartly you invest. So, put on your coach’s hat, draft your retirement investing playbook, and get ready to score big in the game of life!

Higher for Longer Interest Rates

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What Can An Investor Do About High Interest Rates?

While inflation has been gradually decelerating, the Personal Consumption Expenditures (PCE) price index, a key inflation metric used by the Federal Reserve, was up 0.3% for April 2024 and 2.7% year over year. This means that inflation remains stubbornly above the Fed’s 2% target. As a result, the central bankers are likely to keep interest rates higher for longer to bring price pressures fully under control. Lowering rates too soon could let inflation stick around, so the Fed will probably keep interest rates where they see clear signs that inflation is under control.

In this ‘higher for longer’ interest rate environment investors need to play defense like a championship team protecting a lead.

Bond Investments

For now, bond investors should continue to focus on short-term bonds and floating rate funds that can benefit from higher yields without too much interest rate risk. Active bond managers who can adapt to changing conditions might be a better bet than index bond funds.

Stock Investments

For stocks, look for companies with strong balance sheets and reliable dividends. These companies can better handle high interest rates compared to heavily indebted ones. Funds that focus on value, quality, and dividends are smart choices because they invest in companies that can handle economic bumps caused by the current high rates.

Diversification

Diversification across asset classes, sectors, and investment styles is key to reducing risk. It’s like having a balanced team with a strong offense and defense. Above all, maintain discipline around your asset allocation plan based on your goals and risk tolerances. Staying diversified and rebalancing your portfolio can help during volatile times, just like keeping your cool and sticking to your strategy in the final minutes of a tight game.

Higher for Longer Interest Rates thanks to PCE inflation leveling off.
Personal Consumption Expenditures (PCE) Price Index
Source: Morningstar and Bureau of Economic Analysis

Inflation Protected Bonds

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Battling Inflation with Inflation Protected Bonds

Introduction: Inflation – The Retirement Nemesis

Inflation is like a sneaky thief that can chip away at your retirement savings. Just when you think you’ve secured your future, rising prices can erode your purchasing power, leaving you with less than you planned. Fortunately, there’s a defensive play in your investment playbook: inflation protected bonds, specifically Treasury Inflation-Protected Securities (TIPS). These financial instruments are designed to help you keep pace with inflation, ensuring your retirement savings maintain their value over time.

Understanding Inflation Protected Bonds

Inflation protected bonds are a type of fixed-income investment that periodically adjust their principal and interest payments based on inflation. The most well-known of these are TIPS, issued by the U.S. Treasury. Unlike traditional bonds, where the interest payments and principal are fixed, TIPS’ values are tied to the Consumer Price Index (CPI), which measures inflation. This feature ensures that the interest income received by investors keeps pace with inflation, further enhancing the inflation-hedging capabilities of these securities.

Why Inflation Protected Bonds Matter

Here’s why inflation protected bonds or TIPS are important:

  • Protection Against Inflation: The principal value of TIPS increases with inflation and decreases with deflation, ensuring that your investment keeps pace with the cost of living.
  • Stable Income: While the interest rate on TIPS is fixed, the actual interest payments vary because they are applied to the adjusted principal. This means your income from TIPS can grow in an inflationary environment.
  • Diversification: Adding TIPS to your portfolio can provide a hedge against inflation, balancing out other investments that might suffer when inflation rises.

Mutual Funds and ETFs: The Easy Way to Invest in TIPS

Investing directly in TIPS is an option, but for most retirement investors, mutual funds and ETFs that focus on inflation protected bonds offer a more accessible and diversified approach.

Benefits of TIPS Mutual Funds and ETFs

  • Diversification: These funds hold a variety of TIPS with different maturities, reducing the risk associated with any single bond.
  • Liquidity: Mutual funds and ETFs can be bought and sold easily, providing greater liquidity than holding individual bonds.

Short-Term vs. Long-Term TIPS: The Winning Strategy

Short-term TIPS typically have maturities of five years or less. These bonds are more responsive to changes in inflation, providing quicker adjustments to your investment’s principal value. Here’s why they’re beneficial:

  • Lower Interest Rate Risk: Short-term TIPS are less sensitive to interest rate changes. When interest rates rise, the prices of longer-term bonds typically fall more significantly than those of shorter-term bonds.
  • Faster Inflation Adjustment: Since short-term TIPS mature sooner, their principal is adjusted more frequently, helping you keep pace with inflation more effectively.
  • Flexibility: With shorter maturities, these bonds offer greater flexibility, allowing fund managers to reinvest in new TIPS more frequently as market conditions change.

Long-Term TIPS: More Stability but Higher Risk

Long-term TIPS have maturities extending beyond ten years. While they offer protection against long-term inflation, they come with higher interest rate risk. The longer maturity means their prices can be more volatile in response to changes in interest rates.

Adding TIPS to Your Portfolio

Incorporating TIPS into your retirement portfolio requires a strategic approach. Here’s a step-by-step guide:

  • Assess Your Risk Tolerance: Understand how much risk you’re willing to take. If you’re more conservative, you might allocate a larger portion of your fixed-income investments to TIPS.
  • Determine Your Inflation Outlook: Consider economic forecasts and your own expectations about future inflation. If you anticipate high inflation, increasing your TIPS allocation could be beneficial.
  • Choose the Right Mix: Decide between short-term and long-term TIPS based on your risk tolerance, inflation outlook, and known future liabilities, such as retirement expenses or healthcare costs. A blend of both can help match the growth of these liabilities, ensuring sufficient funds are available when needed.
  • Diversify: Don’t put all your eggs in one basket. TIPS should be part of a diversified portfolio that includes other asset classes such as stocks, traditional bonds, and alternative investments.
  • Monitor and Adjust: Keep an eye on economic conditions and your portfolio’s performance. Be prepared to adjust your TIPS allocation as needed to stay aligned with your retirement goals.

Inflation Protected Bond Investment Fund Insights

iShares 0-5 Year TIPS Bond ETF (STIP)

The iShares 0-5 Year TIPS Bond ETF (STIP) targets US Treasury Inflation-Protected Securities (TIPS) with maturities of less than five years, offering a focused approach to short-term inflation protection. This ETF provides a reliable hedge against inflation with lower interest rate risk compared to long-term TIPS.

iShares Short-Term TIPS Bond Index Fund (BAIPX)

The iShares Short-Term TIPS Bond Index Fund (BAIPX) is a mutual fund designed to provide inflation protection by investing primarily in U.S. Treasury Inflation-Protected Securities (TIPS) with maturities of less than five years. This fund provides a hedge against inflation with lower interest rate risk than longer term funds.

Schwab U.S. TIPS ETF (SCHP)

The Schwab US TIPS ETF (SCHP) offers broad exposure to US Treasury Inflation-Protected Securities (TIPS) across various maturities. This ETF provides a balanced approach to inflation protection with a low expense ratios, making it a cost-effective choice for investors.

Fidelity Inflation-Protected Bond Index Fund (FIPDX)

The Fidelity Inflation-Protected Bond Index Fund (FIPDX) is a mutual fund that aims to track the performance of a broad index of US Treasury Inflation-Protected Securities (TIPS). While it has a longer duration, it provides solid protection against long-term inflation, making it suitable for investors with a longer investment horizon.

The Bottom Line: Secure Your Retirement with TIPS

Just as a seasoned coach adjusts the game plan to counter the opponent’s strengths, you need to adapt your investment strategy to combat inflation. TIPS, particularly short-term TIPS, offer a robust defense against the eroding effects of rising prices. By incorporating TIPS into a well-diversified portfolio through mutual funds or ETFs, you can simplify your investment process while ensuring your retirement savings stay in the game, no matter how high inflation climbs. Consequently, this provides you with a good chance to enjoy a fun-filled retirement without worrying about inflation eating into your hard-earned savings.