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Rebalancing in Good Times and Bad

Key Takeaways

  • Losses in the stock market are temporary. The combined total of the thousands of companies within our clients’ portfolios will continue to innovate, generate profits, and provide value over the long-term.
  • In rising markets, we may sell some stocks and buy bonds. In declining markets, we may sell bonds and buy stocks.
  • Research shows there is no proven way to time the market successfully. History argues for staying put through good times and bad.

We all know the stock market goes through periods of ups and downs. But when we have jaw-dropping declines as we’ve experienced since the beginning of March, it can be very difficult psychologically and emotionally to continue buying stocks. The headlines inundate us 24/7 with negative news and doomsday predictions. As rational people, it goes against our nature to put more money into something like stocks that have already lost 20 to 50 percent this year. By the way, I’m not immune to this negativity and pessimism, and I’ve been in the advisory business for a long time.

Over my career, I’ve learned that losses in the stock market are temporary and that the thousands of underlying companies within our clients’ portfolios will continue to innovate, generate profits, and provide value over the long-term.

Because emotions can be such a powerful influence on our decisions, we employ a very disciplined and methodical approach to structuring and managing our clients’ portfolios. When emotion is left out of the equation, you’re less likely to try to time investments in or out of the market and speculate on which sector or company will be the next “hot” area to invest in.

Part of our disciplined approach includes ensuring that every Soundmark client has an investment policy statement and portfolio based on their long-term planning needs. We rebalance each portfolio during the good times and bad to ensure clients stay on track with their long-term goals.

The portion of your portfolio that’s allocated to stocks is designed for long-term growth. To “pay” for this long-term growth, you’ll need to endure some short-term volatility at times. Though short-term volatility can be painful, almost everyone needs the long-term growth potential that stocks provide to stay ahead of inflation. Stocks are also needed to help sustain your nest egg through a retirement that may last 20 to 40 years.

Bonds are an important component of your portfolio as well. They provide income and help reduce volatility. Though bonds may seem like a safer alternative to stocks, bonds can also experience volatility and their returns may not be much more than inflation, especially after taxes. As you approach retirement, it’s even more important that your portfolio includes a mix of stocks and bonds.

Are you in the accumulation phase or distribution phase of life?

Generally speaking, our clients are either in the accumulation phase (i.e. pre-retirement) or the distribution phase (retirement). Each phase may have a slightly different approach to rebalancing.

1. Accumulation Phase

During this phase of life, you’re earning money from work or other sources and you’re saving some of that money in your portfolio for retirement. In the accumulation phase, your portfolio is generally more aggressive than it is during the distribution phase, with a higher allocation to stocks. As you contribute new money to your portfolio, we allocate the funds to both stocks and bonds. If the market is rising, a higher percentage of your contributions may be used to buy bonds instead of stocks. If the stock market is falling, we may commit a larger percentage of your contributions to stocks compared to bonds, since stocks are suddenly less expensive.

During extreme movements in the market, we may do an entire rebalance of your portfolio. If the stock market has increased significantly, we may sell some stocks and buy bonds. Likewise, If the market has experienced a substantial decline, we may sell bonds and buy stocks.

2. Distribution Phase

During the distribution phase, money is being distributed from your portfolio to sustain your standard of living during retirement. As much as possible, we try and set up a monthly draw from your portfolio to help you manage your cash flow and provide consistent rebalancing. Your allocation to stocks during the distribution is less than it is during the accumulation phase. Bonds help reduce volatility in your portfolio and provide income for distributions.

When the market is rising, a higher percentage of your distributions will come from stocks; when the market is falling, more of your distributions may come from bonds. During periods of extreme declines in the stock market like we’ve recently experienced, we may rely on the income and principal of your bond portfolio for distributions as we allow the stock portion of your portfolio to recover from its temporary unrealized losses.

Market Timing

Trying to guess what the market will do over the short-term is fraught with peril. As shown in the attached document from Dimensional Fund Advisors, if you had invested $1,000 in the S&P 500 on January 1, 1970, that investment would have grown to $121,353 by March 17, 2020. However, if you were in and out of the market and missed the S&P 500’s five best days during those 50 years, your investment would be worth $77,056. Note: some of the market’s best single days can occur during a bear market. Is the risk of underperformance worth it if you believe in the long-term viability of the market? I don’t think so. As the adage goes: “buy low and sell high.”

With our methodical approach to investing and rebalancing, we can safely remove emotion from the decision-making process and prevent our clients from making costly and impulsive decisions that dramatically erode their wealth. Contact me any time you or someone close to you has concerns about asset allocation or retirement readiness.

Todd Flynn, CPA, CFP® is a Principal at Soundmark Wealth Management, LLC. Todd works closely with physicians, business owners, and other high net worth individuals to help them define their financial goals and implement an ongoing financial planning process.

This report is intended to be used for educational purposes only and does not constitute a solicitation to purchase any security or advisory services. Past performance is no guarantee of future results. An investment in any security involves significant risks and any investment may lose value. Refer to all risk disclosures related to each security product carefully before investing. Soundmark Wealth Management, LLC, its advisors and its affiliates do not provide tax or accounting services. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for, tax or accounting advice. Please consult with your tax advisor prior to engaging in any transaction.

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