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When should you change your portfolio distribution?

There are two types of investing. Passive investing is when you use a specific model to invest in buckets of stocks across a predetermined balance of stock market sectors. Passive investments are typically “buy and hold,” meaning you won’t need to rebalance as often. When should you change your portfolio distribution for a passive investment fund? Most investors do that quarterly.

The second type of investing is “active.” Rebalancing an active investment portfolio happens more frequently because the investor uses fundamental analysis to track events and economic shifts that affect market movements. Active investors are more likely to buy or sell individual stocks in between scheduled rebalancing periods.

In today’s article, we’ll discuss different ways to rebalance your portfolio based on the type of investor you are. We’ll also talk about time horizon, retirement accounts, investment strategies and long-term capital gains taxes. This information is invaluable if you’re self-managing your investment accounts. So, grab a cup of coffee and settle in to absorb it all.

Portfolio Construction for Retail Investors

Most financial advisors don’t construct investment portfolios for their clients. They buy models from third-party providers. Retail investors don’t have that same luxury. They can certainly use robo advisors that make investing simpler, but those apps generally invest heavily in ETFs, not individual stocks or bond funds. If you want those, you’ll need to do it on your own.

One approach to portfolio construction is to use modern portfolio theory (MPT). American economist Harry Markowitz introduced this investment strategy in 1952 and it became the industry standard through much of the 20th century. Markowitz suggests investing in eleven different market sectors, a sensible strategy for risk averse investors wanting to minimize downside.

MPT worked well before the year 2000 because the status quo of the economy didn’t change much. In the 21st century, the events of 9/11, the housing crash of 2008, and the 2020 pandemic have created market volatility that’s affected profitability in key sectors. Overall, S&P returns are down from 9.81% in the 20th century to 6.90% this century. That’s a 3% hit to your bottom line.

Assuming your investment goals and time horizon haven’t changed, you now need to be more selective about which sectors you invest in. The technology sector has experienced the biggest growth since 2000, and that’s expected to continue. Other sectors, like healthcare and real estate, are more volatile. Investing in those will depend on an individual’s risk tolerance.

When should you change your portfolio distribution for a 60/40 fund?

Managed retirement accounts, like 401(k)s and 403(b)s, are generally constructed with a mix of stocks and bonds. You might also see target date funds in the mix, like a mutual fund. The plan administrator bases the mix on the investor’s risk tolerance, then rebalances the account periodically as the market moves. Quarterly or annual rebalancing is the norm.

These types of funds are tax advantaged accounts because contributions to them are tax deferred. With a managed fund, you won’t be rebalancing your portfolio, but you can use the holdings mix as a blueprint to create your own personal investing plan. One example of this would be investing more heavily in stocks when bond returns are down.

The 60/40 model, which is 60% equities and 40% bonds, can be applied to a single account or all your investment accounts combined. That includes your retirement plan. Retail investors often use their 401(k) as a starting point to build a new portfolio on retail trading platforms like Schwab or Robinhood. We’ll delve into how to manage that in the next section.

When should you change your portfolio distribution for a standard Retail Investment Portfolio

Suggesting that you need to rebalance assumes that you have an investment model in place. If you’re a passive investor, you’ll only need to rebalance quarterly. Active investors who trade frequently might want to look at their asset allocation mix more frequently. It’s easy to go off track when you’re buying and selling daily. That’s more trading than investing.

This is where understanding the 21st century stock market comes into play. The Black Swan Events of the past twenty-three years have changed the behaviors of professional financial advisors and retail investors. Prior to 2001, it was unheard of to sell off long-term investments. Today, companies rise and fall more swiftly. That requires a pro-active approach.

Consider Netflix (NFLX) as an example. They’ve been one of the more resilient companies on the market since they debuted in 2002, but they bottomed out last year and aren’t likely to recover. While rebalancing, you might want to consider replacing them with Amazon (AMZN) or Nvidia (NVDA) to maintain your tech sector mix and increase your returns.

Think of each market sector as a separate bucket. Your portfolio model requires that each box weigh a certain amount. How you fill it is not specified. Some investors choose to use ETFs across the board. There’s several to choose from in each market sector. Others pick individual stocks based on historical returns. Neither technique changes the balance.

Invest in Some Research Tools to Help You with This

Asking “When should you change your portfolio distribution?” is only one part of this. Few retail investment platforms offer rebalancing tools to make this simpler for you. If you’re going to do it yourself, you’ll need to invest in some research and analytics tools that will allow you to rebalance when it becomes necessary.

Another thing to keep in mind when you rebalance is that selling certain holdings could incur a tax liability. Long term capital gains taxes are typically lower than short term capital gains taxes, so you’ll want to hold onto certain stocks longer if you can. Tax loss harvesting can also be part of your rebalancing strategy to offset some of those capital gains taxes.

Self-managing your investment accounts is not something to be taken lightly. Those who can’t dedicate the time to doing research and watching the market should either hire a wealth manager or use a robo advisor. If you’re just getting started in retail investing, do extensive research, and ask other investors lots of questions. Knowledge is the key to success.

Kevin D. Flynn is a former financial professional, business coach, and freelance financial writer. He lives in Leominster, Massachusetts with his wife Evelyn, two cats, and ten wonderful grandchildren. When he’s not working, you’ll find him at the golf course or on his back porch reading classic sci-fi novels.


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