The Importance of Balance

One of the many highlights of this summer’s Olympic Games was watching the U.S. women’s gymnastics team win a gold medal, with outstanding performances from Jordyn Wieber and Gabby Douglas.

Balance is a critical component of all of the gymnastic events, as well as just about any other sport. Without balance, your body cannot maintain the levels of precision necessary to run the bases, shoot a basketball, leap a hurdle while running as fast as possible, or nail a 2 ½ somersault with 2 ½ twist dive in reverse position off the 10m platform, as Nick McCrory and David Boudia did in synch (!) to win a bronze medal.

Similarly, to achieve long-term success, your financial life needs balance, too. How do you fine tune the balance between spending now and saving for later? And how do you balance that spending on essential needs (bills, mortgage, insurance, etc.) versus less essential wants (dining out, upscale cars, the latest i-Thing, etc.)?

Your investment portfolio needs balance, too. We spend a lot of time thinking about the appropriate mix of stocks, bonds and cash in client portfolios, so that we can hope to achieve a desired investmentreturn with the least amount of volatility. (In this case, volatility refers to the degree to which the value of a portfolio moves up and down. Higher volatility means more dramatic fluctuations.)

But over time – due to deposits, withdrawals, or just changes in the market – the mix shifts. The portfolio might now have a higher stock or bond allocation than we originally wanted, which means that it no longer has the return/volatility characteristics we set out to design.

For example, consider a portfolio that in 1991 was made up of 50% bonds and 50% stocks (split evenly between large and small company stocks). Assuming no changes to the portfolio, by 2001 the mix would have shifted to 67% stocks and just 33% bonds. That new portfolio is now much more volatile than the original 50/50 mix due to the higher stock allocation.

To restore the balance of the portfolio, we need to sell things that are above their target and buy things that are below their target, a process referred to as rebalancing. It’s debatable that rebalancing adds much in terms of enhanced returns, but it definitely reduces volatility. According to an analysis by Morningstar, from 1990 – 2011 a portfolio consisting of 60% stocks, 30% bonds and 10% cash that was rebalanced annually was about 30% less volatile than a portfolio that wasn’t rebalanced at all.

There are a number of schools of thought about the appropriate triggers and schedule for portfolio rebalancing. At Woodward Financial Advisors, we review portfolios at least two times a year for rebalancing purposes, as well as when clients make deposits or need to make unanticipated withdrawals.

But regardless of the timing/triggers used, rebalancing seems to be one of the few tools investors have at their disposal to help manage volatility and give themselves a better chance of ending up on the medal stand.