Quarterly Investment Foundations Third Quarter 2024

Mastering The Subject

Rebalancing for Consistent Harvests

If you have ever grown a garden, you know that pruning your plants at the right time can help them to provide a consistent and plentiful harvest. Letting a fruit tree get overcrowded on the sunny side will lead to boom and bust years. Similarly, “pruning” a portfolio through rebalancing can lead to more consistent and plentiful returns. Rebalancing involves periodically adjusting the weightings of different asset classes by buying or selling assets to realign the portfolio with the desired target allocations; following a process to do this will benefit investors over the long term.

Why Rebalance?

Over time, the performance of different asset classes can cause the portfolio's asset allocation to drift away from the original target. For instance, if stocks outperform bonds, the equity portion of the portfolio will grow larger than intended, increasing the overall risk exposure. Conversely, if bonds outperform stocks, the portfolio may become too conservative, potentially limiting growth opportunities. Rebalancing helps restore the desired risk-return profile and creates a disciplined "buy low, sell high" approach, as investors sell appreciated assets and reinvest the proceeds into undervalued ones. In the long run, systematically rebalancing a portfolio can increase returns and reduce volatility of the portfolio value.

When to Rebalance?

There are two main approaches to determining when to rebalance: periodic rebalancing and threshold rebalancing.

1. Periodic Rebalancing: This involves rebalancing the portfolio at regular intervals, such as annually, semi-annually, or quarterly, regardless of how far the allocations have drifted from their targets.

2. Threshold Rebalancing: With this method, rebalancing occurs when an asset class deviates from its target allocation by a predetermined threshold. For example, if the target allocation for stocks is 60%, rebalancing may be triggered if the stock allocation exceeds 65% or falls below 55%.

Research has shown that rebalancing less frequently using predetermined thresholds can lead to higher returns and reduce trading costs compared to a more frequent approach. Being a firm that is evidence-based in its approach to investing, Grand Wealth has been implementing threshold rebalancing successfully for many years.

Benefits of Threshold Rebalancing

1. Risk Management: Rebalancing helps maintain the desired risk level of the portfolio by preventing any single asset class from dominating the allocation.

2. Disciplined Investing: Using thresholds implements a "buy low, sell high" approach, which can enhance long-term returns over more frequent periodic rebalancing.

3. Behavioral Advantages: Rebalancing can help investors avoid the temptation of chasing hot asset classes or jumping ship when a bear market comes. Sticking to a plan can relieve stress and worry.

Implementation Considerations

While rebalancing offers potential benefits, it's important to consider the costs and practical implications:

1. Transaction Costs: Frequent rebalancing can incur trading costs, such as commissions and bid-ask spreads, which can erode returns over time.

2. Tax Implications: In taxable accounts, rebalancing may trigger capital gains taxes, reducing the after-tax returns.

3. Monitoring and Implementation: Rebalancing requires ongoing monitoring and execution, which can be time-consuming and complex for investors with multiple accounts or complex portfolios.

Ripe Harvests

Portfolio rebalancing is a valuable risk management tool that can help maintain an optimal asset allocation and potentially enhance long-term returns. However, investors should carefully consider the appropriate rebalancing strategy, frequency, and implementation approach that aligns with their unique situation. We cannot know when the exact right time to sell stocks and buy bonds is, or vice versa. We do know that those who have a process and stick with their plan over the long term find ripe harvests over the years.

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Market Check-In:

- Stocks: Stocks continued their hot start to the year on the tailwinds of a stable US economy, easing inflationary pressures, and the promise of lower interest rates later this year. In the US, the Russell 3000 index rose 3.22% for the quarter and is up 13.56% for the year. The largest US companies have outperformed the rest of the US stock market and stocks classified as value and small cap have lagged. In international developed countries, the MSCI World ex-US index lost -0.73% for the quarter yet is up 4.41% for the year. Emerging market stocks fared the best for the quarter, the MSCI Emerging Market index returned 5.13% and is up 7.41% for the year.

- Bonds: While the US Federal Reserve continues to keep interest rates at the highest levels in over a decade, at 5.25%, European Central Banks have begun to lower interest rates with signs of lower inflation. As interest rates fall or rise, the prices of bonds do the opposite. As the US markets absorbed a delayed timeline – the Federal Reserve now expects one rate cut late 2024 instead of multiple – interest rates rose slightly this year. The Bloomberg US Aggregate Bond Index was flat this quarter with a return of 0.07% and is down -0.71% for the year. Checking in on global bonds, the Bloomberg Global Aggregate Bond Index lost -1.10% for the quarter and -3.16% for the year.

- Market Outlook: Uncertainty is the only certainty when it comes to investing and those who are willing to embrace it reap the rewards. The US economy continues to show signs of being able to weather higher inflation while avoiding a recession, yet upcoming elections in November, continued wars, and a shift in global economic competition create uncertainty.  With US stocks hitting all-time highs, it may be tempting to wonder if the run is coming to an end. However, history shows that the average return for the S&P 500 in the weeks after an all-time high are equal to every other week. Successful investing is not measured by one day, week, or year – it is the cumulation of decades and those who stick to their plan will see the rewards.

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_{Disclosure:
This newsletter is for informational purposes only and does not constitute investment, legal or tax advice and should not be used as a substitute for the advice of a professional legal or tax advisor. Certain information contained herein was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness. Grand Wealth Management ("GWM") is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about GWM including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.}