Keep Your Portfolio on Track
Each fund in the Gone Fishin' Portfolio represents a specific percentage of your total portfolio. But over time, those percentages will fluctuate with the performance of the financial markets. For instance, high-grade bonds may finish the year higher, and stocks may be lower.
The job of rebalancing is to bring your asset allocation back to the original target percentages. This controls risk. Over the years, it will also deliver a significant performance boost. Why? Because rebalancing requires you to reduce the amount you have invested in the best-performing asset classes and add to those that have underperformed. Since all assets move in cycles, rebalancing forces you to sell high and buy low.
There are essentially three ways to rebalance:
- You can add new money to those funds that have fallen below your target asset allocation.
- You can sell a portion of the funds that have risen above your target percentage and add the proceeds to those funds that have fallen below it.
- If you are taking out annual distributions to spend, you can pull money from the funds that have appreciated the most, thereby bringing your asset allocation back into alignment.
As investment great John Templeton has said,
“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude and pays the greatest reward.”
Don't thwart the power of this strategy by succumbing to the temptation to buy more of your winning funds (or bail out of your lagging ones). Given enough time, each asset class will experience a down cycle. That's when you'll add to them, when they're cheap and out of favor. Not when they're popular and expensive.
The Beauty of Rebalancing
The beauty of our rebalancing strategy is that it provides you with a clear discipline of what to sell and when. Remember, it's impossible to predict which asset class will be the best- or worst-performing in any given year.
International stocks, for example, may have underperformed last year. But there is no way of being certain that they won't be one of the top performers this year or next. And even if an asset class experiences several years in a row of lackluster performance, which is not uncommon, it's important that you not stray from your discipline.
Research from Ibbotson Associates conclusively demonstrates that the strategy of rebalancing reduces the level of portfolio risk in both market upturns and downturns. But it found that the risk reduction is greater during market downturns.
Regardless of what happens from one year to the next, the advantages of rebalancing are much clearer over a decade or more.
When to Rebalance
How often should you do this? Approximately once a year. The exact date you do it is not important. But there needs to be an interval of at least a year and a day between each time you set your portfolio and rebalance.
Why? Because you’ll avoid paying short-term capital gains taxes by waiting at least a year and a day. (The IRS gives more favorable tax treatment to long-term capital gains.) Unless you hold these investments entirely in a qualified retirement plan – like an IRA or 401(k) – where a fund redemption is not a taxable event.
In short, the Gone Fishin' Portfolio requires you to take only one action a year: rebalancing. It not only reduces volatility but will boost your returns. (Studies show that annual rebalancing can enhance portfolio returns by about 1% a year.) It also helps instill the discipline required for investment success. So do it. And keep doing it, year after year.