Stick To The Plan

Mark P. Bernier, CFA |
Posted on Jan 01, 2018

Over the past two years, the stock markets have enjoyed quite a run and have received a tremendous amount of coverage in the media. In 2017 alone, the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite indexes rewarded investors with returns of 28.11%, 21.83%, and 29.64%, respectively.

Yet some investors who have a mix of stock and bond investments in their portfolios might feel a sense of regret or disappointment that their investment returns fell short of these frequently reported benchmarks. Further, they may be inclined to take action in an attempt to “make up lost ground” ---perhaps drastically altering their investment mix, or even speculating in high-risk investments.

Dramatically altering an investment mix or financial plan may make sense, but only after a thorough assessment. Rebalancing, however, is an action to consider even if your financial plan is under review.

In fact, one of the most important actions we can take as investors is the simple act of rebalancing our portfolios. It is an exercise investors execute to maintain their personal investment risk profile --- the mix of investments that best reflects their return expectations and risk appetite --- and can be a powerful aid in removing the emotion from investing.

Rebalancing portfolios has measureable benefits, aside from maintaining an investor’s risk profile. Consider the following hypothetical example: a $100,000 portfolio consisting of a 60% allocation to the Vanguard Total Stock Market Index Fund (Admiral shares) and a 40% allocation to the Vanguard Total Bond Market Index Fund (Admiral shares) was purchased on December 31, 1999 and rebalanced annually. As of December 31,2017, the average annualized after-tax return was 5.42% (assuming a 25% personal federal income tax rate, 15% capital gains tax rate). The same portfolio, without rebalancing, generated a 4.90% average annualized after-tax return (using the same tax assumptions). The cumulative difference in returns for the rebalanced portfolio compared to the portfolio not rebalanced over the 18-year period would have been over 22%.

Tax implications of rebalancing are an important factor and the new tax law, effective January 1, 2018, may have potential impacts on preexisting financial plans and future investment returns. While the ink is barely dry on the new tax law, and the Internal Revenue Service is preparing guidance updates for tax preparers, the fact that taxes reduce investment returns is unchanged. Investors should consider coordinated advice from tax and investment professionals, and perhaps legal counsel for more complex plans, in an effort to prevent unintended tax consequences.

Overall, “Sticking to the plan” of regular portfolio rebalancing and financial plan reassessment can provide investors with the best probability of reaching their investment goals.

Mark P. Bernier, CFA
Senior Vice President/Wealth Management Officer at ACNB Bank