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Why Smart Investors Diversify and Rebalance


A disciplined investing strategy means ensuring your portfolio has a broad enough mix to protect you against economic and market volatility.

investing, diversification

We recommend that one should strive to build a diversified portfolio of various assets whose returns don’t all tend to move in the same direction. If one asset class “zigs” while others “zag,” you can potentially offset some of the impact of the declining asset. This often conjures up the old saying “don’t put all your eggs in one basket.”

Let’s go a bit deeper. In our view it is also important to stay diversified within each major asset class. You can diversify equity investments by investing in stocks of companies that are of different sizes (large, mid, small) and across various industries (sectors) and vary by geographic location (US, international developed nations, emerging market nations). Since markets, sectors and regions will not necessarily thrive at the same time, you can help reduce your portfolio’s risk and volatility by investing across different parts of the stock market.

Similarly, you can diversify the bond portion of your investments by including bonds with different maturities and credit qualities, as well as by buying government and corporate bonds and bonds from different regions.

Did you know that rebalancing can help maintain appropriate risk levels over time?

It is difficult not to be emotionally affected as you observe certain investments in your portfolio perform well or decline in value. When markets are doing well, people tend to want to buy more of that investment. This is often referred to as “chasing returns” or “investing by looking in the rear-view mirror.” Likewise, many people want to sell an investment during times of declining market value.

Instead of buying when markets are high or selling when markets are low, we recommend that one should stay disciplined about maintaining the asset allocation that targets the level of risk that is appropriate for one’s goals, time horizon and tolerance for volatility. In order to maintain the appropriate allocation, you need to periodically rebalance by selling assets that may have appreciated above your target and buying assets that are below your target level. Note, this often means that you sell assets that have done well and buy more of an asset class that has declined. “Selling high” and “buying low” can seem counterintuitive if your emotions tell you to do the opposite.

For example, some clients had a particularly difficult time staying committed to their asset allocation during the market downturn of 2008 and 2009. We had to talk a few clients “off the ledge” to not sell out of equities and move to cash. For those clients who stayed the course and remained fully invested during this difficult period, this meant they were buying more equity investments when U.S. equity markets were at historic lows. Adhering to such a strategy with a diversified 60/40 portfolio made up of the S&P 500 and Barclays Aggregate Bond Index, one would have recovered fully from the S&P 500 Index’s low point in a bit under two years (whereas the S&P 500 Index on its own took more than three years to return to its November 2007 level).

Many who sold low and moved to cash struggled with deciding when was the “right” time to get back into the market, and they may still be playing catch-up.

If you don’t rebalance, a prosperous stock market and a resultant higher allocation to stocks could expose your portfolio to more risk and volatility than is appropriate for you. Remember that stocks typically are more volatile than bonds, and your portfolio would be exposed to an increased likelihood of larger ups and downs. Rebalancing allows you to realign your investment mix to the appropriate allocation and risk level for your goals. Emotions and investing do not mix well.

How should you determine the appropriate allocation for you?

There is no right or wrong answer to this question, because each individual’s circumstances are unique. The mix of stocks and bonds is typically based on your goals and timeframe and your appetite for risk. If you have a longer period of time to invest until your targeted goal (retirement for example), or if you have a greater tolerance for ups and downs in your portfolio, then you may be more comfortable with a greater allocation to stocks. Conversely, if your goal is only a few months or years away, or if your stomach does flip flops every time the stock market drops, then you probably will be more comfortable with a lower allocation to stocks. As previously stated, stocks tend to be more volatile than bonds, but they tend to have a higher appreciation potential, and longer timeframes can help smooth out short- term volatility.

Remember that asset allocation is not a “set it and forget it” activity. Once you determine your target investment mix, you need to review your portfolio periodically and rebalance to maintain a risk level that is appropriate for you. Consult with a financial advisor or investment professional for help with any of these steps and consider the associated tax ramifications of selling investments with embedded capital gains or losses.

Modera Wealth Management, LLC ("Modera") is an SEC registered investment adviser with offices in Boston, MA, Atlanta, GA, Hernando, FL and Westwood, NJ. SEC registration does not imply any level of skill or training. Modera and its representatives are in compliance with the current registration and notice filing requirements imposed upon SEC registered investment advisers by those states in which Modera maintains clients. Modera may only transact business in those states in which it is registered/notice filed or qualifies for an exemption or exclusion from registration/notice filing requirements. For additional information about Modera, including its registration status, fees and services and/or a copy of our Form ADV Disclosure Brochure, please contact Modera or refer to the Investment Adviser Public Disclosure Web site (www.adviserinfo.sec.gov). A full description of the firm's business operations and service offerings is contained in our Disclosure Brochure which appears as Part 2A of Form ADV.

This article is limited to the dissemination of general information regarding Modera's financial planning and investment advisory services to United States residents residing in states where providing such information is not prohibited by applicable law. Such general information is not suitable for everyone. Accordingly, this article should not be construed by any consumer and/or prospective client as a solicitation to effect, or attempt to effect, transactions in securities or as the rendering of personalized investment or financial planning advice for compensation. Past performance is no guarantee of future results, and there is no guarantee that the views and opinions expressed herein will come to pass. Investing in the equity and other markets involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered a solicitation to buy or sell any security or to engage in a particular investment or financial planning strategy. Diversification does not guarantee a profit or guarantee against a loss. Nothing contained herein should be interpreted as legal, tax or accounting advice, nor should it be construed as personalized financial planning, investment or other advice. You should contact your tax advisor, accountant and/or attorney before making any decisions with tax, accounting or legal implications. Past performance is no guarantee of future results.

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