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Portfolio Rebalancing

Spring Offers a Perfect Time for This Important Portfolio Management Task

Just as green-thumb hobbyists are busy this Spring prepping their flower and vegetable gardens for the upcoming growing season, (cleaning out last years’ waste, adding fertilizer and weed preventatives to their soil, and making sure there is proper water drainage, among other tasks), investors too might find Spring an ideal time to review their portfolio holdings and make necessary rebalancing changes for long term goals.  This article will review the importance of rebalancing and how to accomplish this crucial portfolio management task.

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Building a Better Balanced Portfolio

Craig L. Israelsen, Ph.D.
www.7TwelvePortfolio.com
April 2017

It’s time for a better “balanced” portfolio.  Way back when, there were two dominant investment categories (or asset classes), namely US stock and US bonds.  These two assets became the mainstay ingredients in balanced mutual funds, with the typical ratio being a 60% allocation to large US stocks and a 40% allocation to bonds. 

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The 7Twelve® Portfolio: An Introduction

Craig L. Israelsen, Ph.D.
www.7TwelvePortfolio.com
 January 2017

This brief report introduces a multi-asset portfolio design that brings a higher standard to the notion of “diversified”.  This design is referred to as the 7Twelve portfolio.

The name “7Twelve” refers to “7” asset categories with “Twelve” underlying mutual funds.  The seven asset categories include:  US stock, non-US stock, real estate, resources, US bonds, non-US bonds, and cash.   The 7Twelve model is shown below in Figure 1.

The 12 mutual funds utilized in the 7Twelve design can be index funds, exchange traded funds (ETFs), or regular mutual funds.  All 12 funds are equally weighted in the “core” 7Twelve model (each with an allocation of 8.33%).  The equal-weighting is maintained by periodic rebalancing.  There are also three “Age Based” versions of the 7Twelve model that progressively reduce the risk of the portfolio.

You can build the 7Twelve portfolio using mutual funds and/or ETFs from a variety of mutual fund companies.

Figure 1.  The 7Twelve Portfolio Model

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The performance of the 7Twelve model (Active version and Passive version) over the past 15 years is shown in Table 1.  Three mutual funds are also included as comparisons:  Fidelity Global Balanced, Vanguard Balanced Index, and Vanguard 500 Index.

As shown below, the 7Twelve models (the Active 7Twelve that uses actively managed funds and the Passive 7Twelve that uses ETFs) outperformed the comparison funds over the past 15 years.

Table 1.  15-Year Performance of 7Twelve vs. Comparison Funds   (as of 12/31/2016)

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The core 7Twelve model equally weights all 12 asset classes (mutual funds) at 8.33% each as shown below.  For those wanting to build one of the 7Twelve Age Based models the suggested allocations for each of the 12 asset classes are shown below in Table 2.

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Table 2.  Portfolio Allocations for the 7Twelve Core Model and Age Based Models

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Rebalancing the 7Twelve Portfolio

Rebalancing is a vitally important element of the 7Twelve design.  Very simply, rebalancing is the process of systematically bringing each of the 12 funds in the 7Twelve portfolio back to their allotted allocation (8.33% in the core 7Twelve model) or the specified allocation if you’ve built an Age Based 7Twelve portfolio (see Table 2).   For example, money is taken out of the funds that performed better in the prior year and deposited into the funds that under-performed in the prior year.  That’s all that rebalancing is—a straight-forward, non-emotional portfolio management protocol.

There is empirical evidence to support the performance advantage of rebalancing.   Over the 15-year period from 2002-2016 the Passive ETF-based 7Twelve with annual rebalancing produced an annualized return of 7.51% compared to 7.11% without rebalancing—a benefit of 40 bps.  That extra performance from rebalancing amounted to an extra $1,602 in account value after 15 years (assuming a $10,000 initial investment).

7Twelve as a Retirement Portfolio

The diversified 7Twelve portfolio performs well as an investment portfolio during the retirement years.  The graph below illustrates the ending account balances on December 31, 2016 of a retirement account with a starting balance of $250,000 on January 1, 2002.  The first year annual withdrawal was 5% of the balance (or $12,500).  The annual cash withdrawal was increased 3% each year producing a withdrawal total of $232,486 over the 15 year period.  Two of the 7Twelve models (Core model and 50-60 model) finished the 15-year period with more than the original balance of $250,000 (shown by the dotted line).

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Building a diversified portfolio is only part of the game plan.
Set a goal to invest 10-15% of your income each year.


Craig L. Israelsen, Ph.D. is an Executive-in-Residence in the Financial Planning Program at Utah Valley University, a portfolio consultant, and the designer of the 7Twelve portfolio (www.7TwelvePortfolio.com) and author of “7Twelve:  A Diversified Investment Portfolio with a Plan” by John Wiley & Sons (2010).  7Twelve® is a registered trademark owned by Craig L. Israelsen.  As always, past performance does not guarantee future performance…just like in the NCAA basketball tournament.

Taking Control of Your 401(K)

Written By: Jason T. Willms

There has been a long held stigma against making changes to a 401(k) plan, but in order to maximize returns, observation and stewardship are imperative. 401(k)’s are designed to ignore short term volatility, but the intelligent investor can capitalize on these fluctuations to strengthen their portfolio for retirement.

  1. Understand Fees & Cost Structure

Managers justify fees as compensation for generating “above average” returns. However, the most successful funds are the ones with the lowest fees. Morningstar research recently released a study by Russel Kinnel that stated the following:

our [Morningstar’s] research continues to find that fund fees are a strong and dependable predictor of future success. We found that the cheapest funds were at least two to three times more likely to succeed than the priciest funds … which clearly indicates that investors should keep cost in mind no matter what type of fund they are considering.”

This being true, an investor can maximize returns by looking for investments with the lowest asset weighted expense ratios. Current holdings with a ratio greater than 1 should be reevaluated and sold to fund the purchase of lower cost comparable investments, i.e. selling an active fund and buying an ETF. Purchases must also be scrutinized using this technique. Any investments that have ratios exceeding 1 should not be pursued. This ensures a low expense ratio for the portfolio as a whole, increasing long term returns.

401(k) investors should also be careful of “target-date” funds because they have costly fee structures. For those with the expertise, move your investment into a standard 401(k) and manage it to reduce costs.

  1. Avoid “Tunnel Vision”

Many investors are guilty of “tunnel vision.” This causes two problems in retirement planning. First, without critical/unbiased evaluation, investors become over confident in their current holdings and “blinded” to any new options. This can result in missing advantageous opportunities that arise in the market, hindering long term growth.

“Tunnel vision” also causes a lack of diversification which exposes investors to unnecessary risk and uncertainty. The most successful investors are those that can be critical of themselves. This self-criticism combined with careful and consistent observation will ensure an appropriately balanced and successful portfolio.

  1. Review and Rebalance Asset Allocation

401(k) holders should be checking their investments at least once a year to avoid the “set-it and forget-it” mentality. 401(k)’s are developed to “weather the storm”, but proper stewardship allows an investor to capitalize on market opportunities and maximize returns. This maintenance ensures appropriate weighting across investment types, proper exposure to different sectors, and protection against valuation changes.

Carolyn Bigda, of Money.com, provides possible rebalancing criteria. She states that if any of your weights are off by more than 5% from the desired mix, then it is time to make some moves.

Current market conditions have seen an inflation of stock valuations, and a momentum shift seems to be on the horizon. This exposes the investor to value loss. In order to combat this, individuals should be looking for “undervalued” or “fairly-valued” investment options by analyzing P/E ratios. Strong companies with low P/E ratios are better protected against changing economic conditions. Another source of undervalued investments is the foreign market. Foreign investments add diversification and tend to have lower P/E ratios, but experience unique risks. A mutual fund or an ETF that operates in that market would be the best option to mitigate foreign investment risks.

Recently, bonds have also been gaining more attention. The Fed just raised rates at their last meeting and this has caused bond valuations to drop slightly. With more possible hikes in the future, bond investments may be more volatile until rates level off. Bonds do still provide a steady income from coupon payments that can be used to bolster a portfolio, but investors should also be looking for other complimentary income streams.

Regardless of investment strategy or preference the most important aspect of successful investing is to be your own active manager and participate in your retirement planning.

  1. Think Big Picture

Thinking “big picture” requires the investor to consider four things: their 401(k), all the other investments they currently hold, their age, and their retirement time frame. Many 401(k) accounts have the ability to defer certain taxes that would be charged on a normal “taxable” account. Simple strategies such as this one could save an investor money every year and result in greater value.

In a “holistic” strategy, taking age into consideration becomes extremely important. The closer an individual gets to retirement, the more stable and secure an investment must become. This is to protect that future income stream necessary in retirement. Younger individuals who are currently working and plan to remain working can implement more aggressive investment strategies.

Current and future market expectations are also crucial to success. Retiring into a bear market can prove catastrophic for an investor completely reliant on equities because they would be selling the stocks while in a downturn. A strategy suggested by Peter Mallouk, president of Creative Planning, would be to hold short term bonds equivalent to five years’ worth of expenses. The use of bonds essentially “locks-in” that income stream regardless of stock market fluctuations and protects the investor from a decline in the economy.

  1. Save, Save, Save!

The importance of saving cannot be overstated. According to Stuart Ritter, of PNC Wealth Management, “How much you save has the biggest influence on your retirement readiness.” The discipline to save and contribute to your retirement account is the foundation of retirement planning because it provides the building blocks to grow through investment. The most successful retirement savers are not the ones who sporadically contribute large amounts, but the individuals that consistently submit contributions that can develop and grow over the long term.

Link to an Informative Fee Study by Morningstar HERE.


Sources

Coombes, Andrea. “It’s Time For Your 401(k)’s Annual Physical.” The Wall Street Journal. Dow Jones & Company, 06 Nov. 2016. Web. 30 Nov. 2016.
http://www.wsj.com/articles/its-time-for-your-401-k-s-annual-physical-1478488440

Bigda, Carolyn. “5 Smart 401(k) Moves to Make Now.” Time. Time, 26 2016. Web. 30 Nov. 2016.
http://time.com/money/4501388/smart-401k-moves-now/?iid=sr-link1

Morningstar, Inc. “Study by Morningstar’s Russel Kinnel Shows Fund Fees Are Proven Predicators of Future Success.” Study by Morningstar’s Russel Kinnel Shows Fund Fees Are Proven Predicators of Future Success. PR Newswire, a Cision Company, 05 May 2016. Web. 30 Nov. 2016.
http://www.prnewswire.com/news-releases/study-by-morningstars-russel-kinnel-shows-fund-fees-are-proven-predictors-of-future-success-300263655.html

 

 

 

Three Important Year-End Tax Planning Tips for Investors

As the close of 2016 quickly approaches, investor’s should start thinking ahead, reviewing and taking advantage of tax saving strategies. Here are three important tips that will help investor’s manage tax consequences, while helping to better manage their investment portfolio(s).

1) Harvest Tax-Losses…
To date, 2016 has been another good year for market performance, which means many funds will be issuing capital gain distributions prior to year-end, which will be included on 2016 tax returns. Regardless, you may have a few investments that have not fared as well, and are trading at values less than what you paid for them. So now is a great time to review these positions, and considering selling these losers to offset capital gains from your winners. Also, if you’ve used the portfolio strategy to ‘double up’ on positions with unrealized losses, and you’ve met the IRS 31 day holding requirement for these ‘double up’ positions, be sure to record the losses as possible for the current tax year. Tip: check with a tax advisor or published IRS forms https://www.irs.gov/ to learn more on the tax rules for offsetting gains with losses.

2) Consider Charitable Gift-Giving…
It’s that time of year again when generous people think of ways to help those less fortunate than themselves. For investors, this is often accomplished by gifting appreciated stock to a qualifying charity. The benefits are many. First and foremost, the benefits from acts of kindness are priceless to both the recipient and donor alike. Additionally, the Internal Revenue Code allows most gifts to be deducted at their current market value rather than at their cost. So, by gifting appreciated securities, the capital gain that would have otherwise been realized is avoided and yet the entire value of the security is gifted for tax purposes. Clearly a win-win situation!

3) Identify Rebalancing Needs…
Investors need to take the time necessary to review and identify any rebalancing changes necessary to reach long-term goals. Investors should focus on rebalancing portfolios consistent with their risk adjusted goals, while managing the tax consequences of their activity. For example, is the current allocation in line with your targeted goals for portfolio asset mix (cash v. bonds v. stocks)? If not, now represents an opportune time to make adjustments, while considering tax planning goals.

Investment Account Manager includes many tools that enable investors to identify tax saving maneuvers. If you have any questions, feel free to post your inquiries on our Facebook page, or contact our technical support team: techsupport@investmentaccountmanager.com.

Portfolio Rebalancing Made Simple

As 2016 is nearing year end, now may be an ideal time for investors to review their portfolio investments, making necessary rebalancing changes.

Rebalancing is the process of reallocating assets within a portfolio. It is a method to help you get your investments back in line with your target allocation of stocks, bonds and short-term reserves. Rebalancing helps investors by shifting money from those investments that have performed well into portfolio underachievers.

Rebalancing is important since asset allocation it is the major determinant of portfolio return. Furthermore, rebalancing can help control risk. Appropriate allocation targets can preserve / grow wealth for a desired level of riskiness, while helping investors to ‘buy low, sell high.” Periodic rebalancing keeps the investor on track.

Listed here are 5 steps to accomplish rebalancing.

Step 1: Determine your asset allocation targets: What allocation of stock/bond/cash is right for you? Not sure? Consider reviewing the asset allocation of target-date mutual funds geared towards individuals in your age group. Such information is widely available on web sites, such as Morningstar, Vanguard and Fidelity. You’ll likely also find questionnaires that you can complete for insight to the allocation targets that are commensurate with your risk tolerance and growth needs.

Step 2: Determine your current asset allocation: Organize investment statements so you can determine your current allocations. Do you understand the composition of your mutual funds and exchange traded funds, and how do these overlap with any individual stock holdings? Review your holdings closely to identify how you are currently allocated by asset type, sector and size.

Step 3: Review your individual holdings: Use available research tools to review/analyze current holdings to spot early warnings signs. Examine performance, short and long term results. Which of your holdings are having the biggest impact on your portfolio performance? Always be sure to think about the tax consequences of any sell decisions while rebalancing, and to collectively consider other portfolios you may be managing.

Step 4: Implement your rebalancing plan: Identify where current allocations need trimming – shift/rebalance money from those asset types that have performed well and reinvest into your portfolio underachievers. Continually review allocation to stay in line with your target allocation of stocks, bonds and short-term reserves.

Step 5: Make it a habit to periodically rebalance your portfolios! Set a schedule – 1 or 2x’s per year.

In summary, portfolio rebalancing helps reduce chances for disproportionate losses if over concentrated in one asset class. Proper allocation is a cornerstone of good portfolio management, and rebalancing helps investors to avoid portfolio ‘drift’, which is critical to your long-term investment success. Rebalancing helps investors to buy low and sell high, and is an important portfolio management task for reaching long-term goals. If you have any questions, feel free to post your inquiries on our Facebook page.