Investments can behave differently over time, which means your portfolio’s allocation could stray from your
initial objectives. But by rebalancing your portfolio periodically, you can help ensure your portfolio is properly
allocated to investments that align with your risk tolerance and help you meet your financial goals.
Key Points
Designed with a Purpose
When you developed your financial strategy, your Edward
Jones financial advisor helped build an asset allocation – the
amount invested in different asset classes, such as stocks and
bonds – that aligned with your goals and risk tolerance. We
pay close attention to asset allocation because it’s been
shown to be the key determinant of how a portfolio’s return
varies over time.
But given the past few years of market performance, your
allocation may have shifted, and you may now be overweight
in stocks relative to your initial allocation, changing the risk
profile of your portfolio. The proper stock/bond mix is critical,
so it’s important to review your portfolio’s asset allocation on
a regular basis and rebalance when needed.
• The asset allocation of your portfolio
should be designed purposefully based
on your goals and comfort level with risk
• Rebalancing can help:
•K
eep your portfolio’s risk exposure
aligned with your risk tolerance
•T
ake the emotion out of investment
decisions
•P
rovide the potential for improved
risk-adjusted returns
• If you don’t rebalance proactively, the
market can do it for you, which can be
a painful process
Why Rebalance?
1 Keep Your Portfolio Aligned with Your Risk Tolerance
How can rebalancing help you manage risk? Suppose
you began investing in 1995 with a portfolio weighted
65% in stocks and 35% in bonds, an allocation that
aligned with your goals and comfort level with risk.
(We selected this time period to include more than
two full market cycles.)
Too Much Can Be Invested in Stocks
Without Rebalancing
Portfolio Allocation to Stocks Without Rebalancing
(1995–2015)
85%
82%
Actual Percentage in Stocks
80%
79%
77%
75%
70%
65%
Desired Percentage = 65%
60%
61%
55%
50%
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Source: Morningstar Direct and Edward Jones calculations. Initial allocation of
65% in S&P 500 Total Return Index and 35% in BarCap Aggregate Bond Index.
The S&P 500 and Barclays U.S. Aggregate Bond indexes are unmanaged and
are not meant to depict an actual investment.
*Brinson, Gary P., L. Randolph Hood, and Gilbert L. Beebower. 1986. “Determinants of Portfolio Performance.” Financial Analysts Journal, Vol. 42, No. 4
(July/August 1986):39–44.
PAGE
PAGE 11 OF 4
To the left, you can see how much your allocation to
stocks would have changed over time if you never
rebalanced your portfolio – which also means the
amount of risk you’d be taking on would be inappropriate based on your objectives.
In fact, if you never rebalanced, nearly 80% of your
portfolio would have been invested in stocks by the
beginning of 2000 – right before the stock market
decline of 2000–2002, and again, nearly 80% in stocks
before the decline of 2008.
Rebalancing your investments regularly could have
helped prevent this overweighting in stocks and kept
the risk exposure aligned with your risk tolerance. It also
would have helped reduce the impact of the declines in
2000 and 2008 on your portfolio, when the market
essentially rebalanced for you.
But proactively rebalancing would also have taken
advantage of the upturn in 2009 by adding to stocks
when you would have been underweighted. That’s
because rebalancing works both ways.
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Maintain Your Balance
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Because of the strong market performance since 2009,
the stock allocation of this portfolio is once again near
80%. This does not mean that a decline is coming – no
one can predict the movement of the market.
And that’s not really the point. The key is to help
ensure your allocation remains aligned with your goals
and risk tolerance.
Two Different Portfolios
Stock/Bond
Allocations
65/35
80/20
Expected Return
5.5%–7.5%
6%–8%
Expected Risk
(Standard Deviation)
10.9%
12.9%
Best 12-month return
(1995–2015)
38%
44%
Worst 12-month return
(1995–2015)
-29%
-36%
An 80/20 allocation has different
return expectations and risk than a
65/35 allocation. While the differences
may not seem that dramatic,
remember that your portfolio should
be designed with your goals and
emotional tolerance for risk in mind,
which we discuss below.
*Source: Edward Jones estimates. Past performance is not a guarantee of future results.
For 1995–2015 period, Stocks = S&P 500 Total Return index, Bonds = Barcap Aggregate
Index. Each allocation is rebalanced annually back to original target percentages.
The indexes are unmanaged and are not meant to depict an actual investment. Standard
deviation is a common measure of volatility. The lower the number, the lower the volatility.
2 Take Emotion Out of Asset Allocation Decisions
When Warren Buffett, perhaps the world’s most
famous investor, said, “Investing is simple, but it isn’t
easy,” he meant our emotions can keep us from following basic investment rules.
Rebalancing runs counter to our emotions. It can force
us to reduce some of our “winners” and add to asset
classes that have underperformed.
But as shown below, we like buying when the markets
are up because we feel good; we sell when the markets
are down because we’re worried. You can help avoid
this bad habit and take the emotion out of investing by
establishing an automatic rebalancing program.
As an example of this, the chart below shows investment dollars moving into and out of stock mutual
funds over the past 25 years, which we use as a proxy
to represent purchases and sales of stocks in general.
During the late 1990s, when stocks were doing well,
many investors didn’t reduce their stock holdings. Instead, they placed more money in stocks, at higher and
higher prices, with the largest amount of buys occurring
at the market peak in 2000. Then, as the stock market
declined in the early 2000s, the average investor sold
stocks at lower and lower prices. The biggest sales
occurred in 2003, represented by the dip in the graph,
just as the market was set to double in value over the
next few years.
$25
$20
$15
$10
$5
$0
-$5
Mar. 31, 2016 = $-1648
million Square Root Scale
-$10
-$15
PAGE 2 OF 4
2015
2016
2013
Source: Ned Davis Research, Inc., March 31, 2016. Past performance is not a guarantee
of future results. Copyright © 2015 Ned Davis Research, Inc. All rights reserved. Further
distribution prohibited without prior permission.
2014
2011
2012
2010
2009
2007
2008
2005
2006
2003
2004
2001
2002
1999
2000
1997
1998
1995
1996
1993
1994
1991
1992
1990
1988
-$20
1989
Here’s what we believe happened: Investors’
emotions caused them to chase performance,
overreact to market conditions and, ultimately,
“buy high and sell low.”
NetU.S.
U.S.Purchases
Purchases
U.S.
Equity
Mutual
Funds
Net
ofof
U.S.
Equity
Mutual
Funds
(in $Billions)
We saw a similar pattern occur more
recently during the market decline of 2008.
Once again, large sales occurred in late 2008
and early 2009, after the market had declined
sharply and just before one of the strongest
market rallies in history.
With a rebalancing program in place, you can sell a
percentage of those assets that, because of significant
price appreciation, have taken on a larger percentage
of your portfolio than you had originally intended. At
the same time, you can buy underweighted assets
whose performance may have lagged but now may be
poised for recovery. In short, you’ll be keeping the asset
allocation of your portfolio in proper alignment with
your goals and risk tolerance.
While the primary goal of rebalancing is to help keep your portfolio’s allocation and risk aligned with your
objectives, a rebalanced portfolio can also help improve your risk-adjusted return potential when compared
to a non-rebalanced portfolio. This means that returns may be similar over time, but you’ll likely experience
less risk along the way. Rebalancing a portfolio can, at times, provide the opportunity for higher overall return
potential with lower risk, as highlighted below using the same 20-year time period as before.
Rebalancing cannot guarantee a profit or protect against a loss. However, having a rebalancing strategy in
place could help improve return potential and smooth out volatility over time relative to a non-rebalanced
portfolio, especially in a market in which the leading types of investments change fairly frequently from year
to year. That said, outperformance should not be your goal – your goal should be to ensure your performance,
risk and allocation are all aligned with your goals.
Issues to Consider
When Rebalancing
Rebalanced vs. Non-rebalanced Portfolio
$600,000
$550,000
$500,000
$450,000
$400,000
$350,000
$300,000
$250,000
$200,000
$150,000
$100,000
'95
'96
'97
'98
'99
'00
'01
No Rebalancing
'02 '03
'04
'05
'06
'07
'08
'09
'10
'11
'12
'13
'14
'15
Threshold Rebalancing
No Rebalancing
Threshold Rebalancing
Annual Return
8.4%
8.6%
Risk
(Standard Deviation)
10.9%
9.8%
Source: Morningstar Direct. Initial allocation of S&P 500 Total Return Index BarCap
Aggregate Bond Index. Past performance is not a guarantee of future results. Rebalancing occurred when either stocks or bonds were +/- 5% from initial 65/35 allocation for
two consecutive months. Standard deviation is a common measure of volatility. The
lower the number, the lower the volatility. The indexes are unmanaged and are not
meant to depict an actual investment.
PAGE 3 OF 4
If rebalancing has all these
benefits, why not do it anytime
your portfolio deviates slightly
from your stated risk tolerance?
Because there are trading costs,
and you could owe taxes from
selling overweighted assets (in
a taxable account). But taxes
should not be the key driver
of the rebalancing decision.
Essentially, you’ll want to
rebalance when the increased
risk to your portfolio (due to
the overweighted positions)
outweighs the trading costs
and potential tax ramifications
associated with it.
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3 Provide the Potential for Improved Risk-adjusted Returns
s,
me
r
ce,
Here are the two most common rebalancing methods:
• Calendar rebalancing – As its name implies, calendar rebalancing is done at regular intervals, such as monthly,
quarterly or annually. If you chose annual rebalancing, for example, your asset allocation would be realigned with
your initial allocation once a year.
• Threshold rebalancing – Using this method, you’ll rebalance when an asset class strays from its target allocation
by a certain amount, or threshold. For example, suppose you establish your initial asset allocation at 65% stocks
and 35% bonds. If you set a 5% threshold for rebalancing, you’ll restore your portfolio to the original 65%/35%
split when the stock portion rises above 70% or falls below 60%.
Which method is better? The main benefit of rebalancing is to prevent your portfolio from wandering too far
from its objectives and taking on too much risk – which could happen at any time of the year. That’s why we
favor threshold rebalancing. However, we believe either method is preferable to not rebalancing at all.
Take Action
Here’s the bottom line: Rebalancing your portfolio can help you work toward your long-term goals without
straying too far from your initial asset allocation and comfort level with risk. In addition to helping take the
emotion out of investing, it also can help smooth out volatility and provide the opportunity for better risk-adjusted return potential over time. Remember, if you don’t rebalance proactively, the market tends to do it for
you, which can be a very uncomfortable process.
So has your portfolio become “out of alignment”? This may mean you need to add money to an underweight
investment or sell some of an overweight investment and reinvest those funds. Your portfolio was designed
to help meet your long-term goals, and it’s important that your allocation still aligns with these goals to keep
you on track. Talk to your Edward Jones financial advisor today about which rebalancing strategy makes
sense for you.
Automatic rebalancing and asset allocation do not guarantee a profit or protect against loss.
Scott Thoma, CFA
Investment Strategist
PAGE 4 OF 4
www.edwardjones.com
Member SIPC
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our
Rebalancing Methods