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The Great Rebalancing

The Great Rebalancing

A friend of mine from a former life resurfaced and asked if I would look at his portfolio, which I was happy to do.

I felt a bit like an emergency room doctor who looks at a patient and can immediately diagnose a very obvious problem, like, his arm is missing.

My friend started out years ago with a small position in Apple, which turned into a very large position in Apple. What was once 2% of his portfolio was now 40% of his portfolio. Basically, his entire retirement was tied to Apple’s fate. People believe in Apple, but it’s still one company—fallible and prone to stupid behavior, like all large organizations are.

So the obvious solution is to rebalance the Apple holding. Sell Apple, and buy other stuff (which we will get to in a second).

People have a tough time rebalancing. A stock does really well for them, and they get attached to it. This is known as endowment effect. People have no problem selling small winners, but they have a hard time selling big winners—even when that position has reached a trillion-plus market cap and probably doesn’t have a lot of growth left in it.

Even when that position has basically become systematic, undiversifiable market risk.

Even when, if you told people they were holding an index, they would probably sell. Psychologically, people just can’t do it when they’re attached to the company.

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We have had a very long bull market and there are quite a few beanstalks that have grown to the clouds. I suspect my friend’s portfolio looks like a lot of people’s portfolios, if they were left alone for a long period of time—one or two home run stocks dominating the returns of the portfolio, with everything else basically going nowhere.

A portfolio is like your landscaping. You have to tend to it every once in a while or it gets overgrown.

You shouldn’t wait to rebalance once every fifteen years. Once every 1-3 years will probably suffice.

Anyway, I wasn’t done playing portfolio doctor. There was one other big, glaring problem.

Asset Allocation

I said to my friend, you are 45 years old. So let’s round up to 50. That means that you should have a 50% allocation to bonds.

Or more.

My friend had a 2% allocation to bonds.

This is an extreme example—but maybe not! I suspect there are a lot of portfolios out there that look just like this one—dominated by one or two stocks, massively loaded up on equities, very underweight bonds.

The subject of asset allocation is a meaty one, and we’re not going to get deep into it here. But if you’re in your 40s or 50s and you’re rolling around with less than 10% bonds in your account, you have a serious asset allocation problem.

Part of the reason this asset allocation problem exists is because people aren’t rebalancing. If you have a 70/30 portfolio of stocks and bonds, what happens when the stocks grow over time and the bonds don’t? You end up with a 90/10 portfolio, even if that wasn’t your original intent.

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Again, take out the hedge trimmers and do some landscaping. It’s great that your stocks have done well. Sell them, and rebalance to fixed income.

Rebalancing is sort of an automatic way to systematically buy low and sell high. By selling your fluffed-up stocks, you can sell high, and buy bonds which are currently low.

Or, you can just buy a balanced fund, which is one-stop-shopping. But some people don’t like to mix their peas and carrots.

Log onto the Brokerage Account and Do It

If you’re not financially-oriented, this might seem hard, and a lot of work. The only thing that’s hard about it is doing something outside of your comfort zone. You had better get used to spending some time outside your comfort zone.

Because this is urgent.

This may sound like a jackass thing to say, but there are few things more important than money. There are few things more important than your level of material comfort in retirement. If you screw this up, and you have to lower your standard of living as a result, it will be an unforced error. An own goal.

I don’t know what’s stopping you from doing it, but you have to log into your brokerage account (click on “forgot password” if necessary), and literally enter buy and sell orders to get everything straightened out.

If you are afraid, or need help, then get help. It is the most important thing you will do this year.

Play Ball

One last thing—if you are a baseball fan (and you are enjoying the playoffs), please check out the latest episode of The Monthly Dirtcast where I interview Matt McGough, former batboy for the New York Yankees. He even wrote a book about it. Tune in.


We welcome your comments. Please comply with our Community Rules.


Laura Barclay
Oct. 17, 2018, 4:53 p.m.

Hi Jared,

Love your writing! My thoughts or comments on this piece is that the manipulations of the FED/Bank of Canada (BOC) put the fixed income side of a portfolio as a natural disadvantage to long term investing. (at the moment) Also, depending on the investor’s potential guaranteed retirement income (pension) there maybe a natural Fixed income hedge for a lifetime investment that doesn’t require a doubling down on the low returns for high quality corporate bonds (forget about gov’ts). In Canada, the top tax rate in my province is 53.51% on interest income, with inflation at a comfortable 1.8% and investment grade corporate bond baskets paying about 3.3% duration of 4.5 years not much to work with let alone cover active management costs. I manage close to $1B CAD for about 200 families. Everybody hates net returns of 1% to 2% even if its their sleep at night money. My thoughts to your comment of 50% is that would produce a very disappointed/frustrated (at worst ex)client missing out on corporate earnings growth and stable dividends. I get there is significant handholding needed for the volatility that presents every decade or so, but that is my role. what about a big focus on high quality companies, paying stable and growing dividends vs any investment grade corporate bond of the same company. Your buddy is 45 will he work and save for the next 15 to 20 years? lots of time to build a bond portfolio. Ignoring ability/aptitude to tolerate risk: if my client needs the money in 0 to 5 years yes bonds, 5 to 10 years balanced, over 10 years equities… my 2 cents worth about 1.5 cents US! totally agree with the rest of your comments about diversification and rebalancing material positions.

Harlen Chapman
Oct. 15, 2018, 12:43 p.m.

Excellent common sense - scarce these days. Thanks, HarlenC

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