Investing and monitoring

Continue the portfolio construction course with module 3, which outlines the last two steps of the portfolio construction process: 1) Benchmarking 2) Budgeting 3) Investing and 4) Monitoring.

Before investing …

Start by determining the objective of the investment so that it is top of mind when assessing which products to invest in. Then, set a fund due diligence process, considering inputs such as exposure, risk, cost and performance.

3 action items before choosing a fund

Remember the objective

What components will help fulfill each need in the portfolio?
Puzzle pieces
Question the due diligence process

Is there an unbiased, thorough process for evaluating pooled vehicles, such as active mutual funds and exchange-traded funds (ETFs)?
Magnifying glass and ruler
Determine the impact on a risk-adjusted return
Is the fund additive to raising the level of risk-adjusted return either by enhancing return or reducing risk? If the answer is no, it should not go into the portfolio.

The last step of the process is to monitor the portfolio’s performance

However, it should be the step that happens most frequently in the portfolio construction process. It is important to check in regularly (monthly or quarterly) to assess whether the investment strategy requires any adjustments.

When to consider readjusting an approach

The clients’ objectives have changed.
Shark fin
There is unintentional risk in the portfolio.
The financial professional’s views on the market or funds’ manager have changed.

Establish a formal review process to evaluate the items outlined above

Establish an investment review process.

This will help assess any changes and track the portfolio’s underlying components. Once a process is set, it should be scheduled regularly for monitoring and executing against any necessary or desired updates to the portfolio. If a change has, or could potentially have a negative effect on the portfolio’s investments, the portfolio may need to be rebalanced.

What is rebalancing?

Rebalancing is the process of shifting the weightings of the assets in a portfolio.

The benefits of rebalancing

Ensure any portfolio change is intentional.

Rebalancing helps to ensure that any changes in the portfolio’s asset allocation are intentional. Rather than allowing the market to make unintended changes to a portfolio’s asset allocation, rebalancing gives the financial professional an active role in taking risks that match their clients’ risk appetite.

For example, without proper vigilance, a 60% stock – 40% bond portfolio could shift to a 70% – 30% allocation with market movements. This would result in an under- or over-allocation to certain exposures. Financial professionals who rebalance their clients’ portfolios are able to better stay on track with the original objectives set in the planning process.

Are there any downsides to rebalancing?

Consider the downsides to rebalancing.

While there are clear long-term benefits of rebalancing, financial professionals experience hesitation from clients due to the short-term drawbacks. 

An annual or semi-annual re-balancing may seem counter-productive because it involves two steps that are typically avoided:

Selling high performing funds to buy lower performing funds
Generating trades that add to the tax bill

However, there are good reasons for both.

Addressing step 1: Why investors should not always keep, or buy more of a fund that has gone up in performance

Lightning bolt
No guarantee of future returns
Selling high performing funds may feel strange but it is important to remember that past performance does not guarantee future results.
Returns are hard to predict
Returns—especially in the short-term—are incredibly difficult to predict. Risk and correlations increase diversification and tend be more consistent and predictable.

Addressing step 2: While investors may be averse to paying taxes, they are even more averse to losing money

In the below hypothetical example, take a 60% stocks – 40% bonds portfolio that started out with a $100,000 investment and was never rebalanced. In the first five years of being invested, the portfolio would have increased in value by 90%. Further, it would be worth $11,000 more than the same starting portfolio that was rebalanced annually (excluding taxes and trading costs). At the surface, that may seem like a good thing.

Portfolio started as a 60/40 on Jan 1, 2003

Annual Rebalancing

No Rebalancing

Ending dollar amount as of Dec 31, 2017 $335,613 $330,522
Annualized Return 8.4% 8.3%
Volatility (annualized standard deviation) 11.3% 13.4%

Portfolio started as a 60/40 on Jan 1, 2003

Ending dollar amount as of Dec 31, 2017
Annualized Return
Volatility (annualized standard deviation)

Annual Rebalancing


No Rebalancing


Source: BlackRock, The Rebalancing Act, 2018.

However, with the market downturn in 2008, the un-rebalanced portfolio would have lost $58,000 versus $42,000 as with the rebalanced portfolio. It took five years for the un-rebalanced portfolio to build its lead, and only one to lose it, and then some. What’s more, nine years later, the un-rebalanced portfolio still lagged behind. Ultimately, rebalanced portfolios can help provide a better investing experience over the long term.

Annual rebalancing can potentially have a stronger return over the long term


Source: BlackRock, Morningstar.

Think differently

Financial professionals who are proactive about setting a due diligence process before investing, monitoring their portfolio once invested and thoughtful about making portfolio adjustments, such as rebalancing, play a big role in helping their clients meet their goals.

This concludes the third module of the portfolio construction course. Read the next module, which discusses how to rethink risk in the investment process, to continue the course.

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