Thursday, August 25, 2011

The Pitfalls of Automatic Portfolio Rebalancing

Was just quoted in the Franklin Prosperity Report on portfolio rebalancing. I would provide you a link to the quote but I sent them my headshot to go along with the quote. There must have been a mixup, they got the quote right but put in someone elses headshot. Below is the quote:

The Pitfalls of Automatic Portfolio Rebalancing
If you participate in a 401(k) or other retirement account, you may have
been given the option to have your portfolio “automatically rebalanced” for
you at set junctures, such as quarterly or yearly.
The idea behind rebalancing is to minimize investing risk by reverting the
balance of stocks and bonds to percentages you initially set, based on
your time horizon to retirement (generally heavier on stocks when you are
younger, more bonds as you age).
For instance, if your portfolio holds 50 percent
stocks and 50 percent bonds, your stock-to-bond
ratio may have shifted to 60 percent stocks and
40 percent bonds during years when the stock
market is rising and equity values appreciate.
Traditional rebalancing basically forces
you to take the profits you made from equities
and use them to buy more bonds, thus achieving that initial 50-50 ratio.
The question is: Should you agree to have your portfolio rebalanced
Absolutely not, says Matthew Tuttle, CFP, MBA, CEO of Tuttle Wealth
Management in Stamford, Conn. “Automatic portfolio rebalancing is stupid,”
Tuttle says. “The idea that you’d rebalance a portfolio based on a calendar
date to me is kind of crazy.”
The correct way to rebalance is to understand the underlying market dynamics
and act accordingly. “The key to safety is staying in harmony with the
major market trends,” Tuttle says. “So, if you see that those trends are
favoring small caps over large caps, you overweight small caps; if stocks
are doing better than bonds, you overweight stocks. To me, age has very
little to do with it.”
Nor does Tuttle like the method of portfolio rebalancing that calls for
investors to increase the portfolio percentage of bonds as they move closer
to retirement.
“Conventional wisdom says that, as investors get close to 65, they should
have most of their portfolios in bonds,” Tuttle says. “That pretty much
guarantees that, at age 80, you’re going to be working at Walmart, because
life expectancy is increasing. I’m going to my grandmother’s 96th birthday
party next month.”
Shifting almost everything to bonds as you age is risky because rising
interest rates will bring capital losses and because bonds don’t keep pace
with inflation, Tuttle says.

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