Welcome to the Bowman financial strategies. Retirement made simple series. Your host is Erik Bowman, retirement income certified professional and certificate holder of the national social security association.

Hi everybody. My name's Erik Bowman. And today we are going to be discussing rebalancing. 

So, what is rebalancing? Rebalancing is the realignment of the assets inside of your portfolio to a targeted ratio. So, for example, if you wanted a targeted ratio of 50% bonds and 50% stocks and the portfolio got out of alignment, because for example, the stock market crashed, and the stocks became a smaller portion of the overall portfolio; you would want to rebalance that portfolio by selling off some bonds and buying more stocks. Interestingly, what this does, and we'll show with a mathematical example is it allows you to sell one asset class at a relative high; and to purchase the other asset class, in this case, stocks at a relative low.

 Which is modern portfolio theory, we always would like to buy low and sell high. 

Let's go into an example to show the contrast between an account that actually is rebalanced and a portfolio that is not rebalanced.

So, we're going to start off with an IRA that has $100,000 in it split evenly 50% stocks and 50% bonds. Let's assume that the stock market goes down by 30% and the bonds increased by 2% over a one-year period of time. Now you're going to have $86,000 in the account. $51,000 will be bonds. $35,000 will be stocks. It's out of our threshold of alignment so we're going to rebalance the account in order to buy those blue arrows. And now we're going to have that $86,000 split evenly 43,000 bonds, 43,000 stocks. And now the stock market recovers and the stocks go up 40% and the bonds go up 2% again. Now your portfolio is going to have over 60,000 in stocks and about 43 to $44,000 in bonds for a total account value of $104,060. 

Let's compare that to a portfolio. That's not rebalanced. We start off with the same $100,000, 50/50 and the stock market does the exact same thing. It decreases by 30% in the stocks and increases by 2% in the bonds, we don't rebalance and then we have the same market, 40% increase in stocks and a 2% increase in bonds. And what you see is your overall value is literally 3% less, or only a little over $101,000. The bonds are now worth over 52,000, but the stocks are only at 49,000. 

So just by simply taking advantage of the rebalancing methodology, without having to try to time the market, that under equal conditions, market conditions, you can see that you ended up with a better rate of return with the account that was actually rebalanced once it got out of its threshold and alignment. 

Now there are three different types of rebalancing that are most commonly known and available. The first one is time only, and then there's threshold only, and then there's a combination of those two. So, let's dig on in. 

Time only rebalancing is a methodical rebalancing plan that removes emotion and can also reduce risk and lower volatility. It's a time only strategy, which means you're going to pick a time whether it's monthly, quarterly, semi-annually, or annually; and you're going to rebalance the portfolio back to your target ratio, regardless of what the current allocation looks like. 

The second type of rebalancing is threshold only. So, threshold only says you're not going to rebalance unless your asset classes get out of sync over a specific threshold that you set. So, you may set a 2% of 5% or a 10% threshold, meaning that the percentage of stocks, if your target was 50/50 stocks and bonds, once it got up to 61%, if you had a 10% threshold, you would be rebalancing that portfolio.

Now there are costs and considerations associated with rebalancing. One of those is taxes. If you have a non-qualified account and you rebalance that account very often, or more than once a year, you could incur short term capital gain. 

Second, there are transaction costs with some custodians that you need to make sure that if you have mutual funds, for example that can have very high transaction fees, you want to make sure that you're not trading so often that the costs outweigh the benefit of the potential increased rate of return from rebalancing. 

If you're watching this on our webpage, please explore around and watch other videos that we have on a myriad of additional retirement topics. Thanks a lot. 

If what you've heard today has prompted, you to want to learn more about retirement planning concepts or more about your personal situation then click on the calendar link to schedule time on my personal calendar, where we can talk about how you can receive your customized tax preparedness and retirement report. To watch other webinars go to Bowmanfinancialstrategies.com and learn about topics like social security, maximization, Roth conversions, and tax efficient distribution strategies and retirement.