Economic and Investment Markets Outlook and Why Rebalancing Matters: Summary from October 18, 2011 Client webinar: (Archived Blog)

This is a summary of the first part of our last client webinar.  A recording of the presentation will be posted to the website soon.

1.  Economic and Investment Markets Outlook and the Big Picture

The recent turmoil in the stock market is the result of concern over Europe’s ability to deal with sovereign debt and the seemingly inability of politicians of all stripes here and there to work together and reach compromise to move toward solutions.  Investors hate uncertainty and are scared.  They have shown a willingness to sell at the slightest indication of trouble.

Perhaps it is useful to step back and look at the big picture.  Here are some stats about the average financial crisis from the book This Time is Different – Eight Centuries of Financial Folly by economics professors Carmen M. Rienhart and Kenneth  S. Rogoff.  See if any of this looks familiar….. (The current financial crisis started in 2007 – 2008)

In the average financial crisis the:

Average decline in housing was 35.5% lasting 6 years (until 2013 – 2014)

Average unemployment 7% for 5 years (until 2012-2013)

Average increase in government debt 186%

Average duration 4.4 years (until 2012 – 2013)


So where are we now?

Stock market prices are relatively low – can buy a $1 of earnings fairly cheap

Interest rates are historically low

Not good for investors

Great for financing capital goods

Great for first time home buyers

Good time to look at refinancing

Government – good time for infrastructure


  1.  Why Rebalancing Matters

Changing direction, let’s talk about Portfolio and Account Rebalancing

“You can let your portfolio drift with the prevailing currents or try to steer a steady course.”

Rebalancing can improve returns (forcing one to sell high and buy low) and reduce risk and volatility (the more volatile assets tend to grow in relative size in the portfolio).

There are a different methods used for rebalancing. One is called Time Period (or Periodic) Strategies.  Here one would rebalance based on a specific time period such as monthly, quarterly,  semi-annual or annually.  Another strategy is called Dynamic (or Threshold) driven.  Here the account is rebalanced based on a percent change in the target weight.  For example: 1%, 5%, 10%, 20%, 25%, 30% etc.

Then there is a Time and Threshold strategy, a combination checking for a threshold at certain periods.  This method has been shown to show the best potential results in improved returns and reduced risk.  This is the method we use.      

There are potential costs to rebalancing that may offset the benefits.  These costs are: 1. Trading or commission expenses.  We avoid this by primarily using mutual funds without transaction fees for rebalancing trades.  2. Tax costs from creating taxable gains and losses.  While we have a firm commitment to not letting the tax tail wag the investment dog, we do factor in the potential tax cost during our year-end tax planning. 3. The time and labor expenses to perform rebalancing. Available technology can keep labor expense down to a reasonable level. These expenses are determined to a great extent by the frequency of rebalancing events. By using research based methodologies and technology, the total costs can be kept very low.

Rebalancing has been shown to work well during 3 different types of periods. 1. When volatility is high like we have been experiencing recently, 2. When correlations between different types of assets are low – different asset classes move and react differently to the same situation – what one might say is more normal times and 3. When the rate of return differentials between asset classes are narrow – when differences in rates of return are close to each other.

In conclusion, while times are difficult and the news only seems to make matters worse, keeping things in perspective and using investment management policies based on research proven strategies can provide some comfort to ride out the storm while providing some reduced risk and return potential.

Year End Tax Planning – Summary from Client Webinar on 10/18/11 (Archived Blog)

Our Thoughts About Yesterday's Stock Market Sell Off (September 23, 2011) (Archived Blog)