Conclusion: Monitoring and Rebalancing Are Stewardship Issues
Monitoring the performance of investment portfolios and rebalancing them in a disciplined fashion are not exactly the most exciting aspects of wealth management, but they are crucial to successful outcomes. We can do everything else right, fail here, and find that we have discharged our stewardship responsibilities poorly.
The phrase “in a disciplined fashion” was not an accident. There are two reasons why families fail to monitor portfolios appropriately and to rebalance them properly. The first is the boredom factor, and the answer to that is the same answer we would give to any boring-but-important job: discipline. It's simply part of the job we have to do, and we have to take the good with the bad. Otherwise, we are not intelligent investors carrying out serious stewardship responsibilities, we are simply dilettantes.
The second obstacle is overenthusiasm or overpessimism. If the markets are in a bull phase, we will be sorely tempted to let our gains run. Some of that is acceptable—markets do tend to be characterized by momentum. But there are limits. We originally set those limits (I hope) in calm moments, before we were faced with temptation. Then, no matter how strong the markets appear to be, and no matter how certain we are that they will continue to rise, once our maximum exposure has been reached we must—must—rebalance. Taking money off the table during strong markets is the way wealth is preserved.
Similarly, overpessimism can also be the enemy of wealth preservation. In a bear market our lower ranges will be frequently tested and often exceeded, and it can be very tempting to ignore the absolute minimum exposures we set for ourselves—or, worse, to abandon those market sectors altogether. All this will do is put us on the sidelines when the recovery occurs. We will have taken our lumps during the bear phase of the market, but we won't get the benefit of the bull phase. This is no way to run a portfolio.
Investors sometimes point out that disciplined rebalancing actually causes harm to a portfolio. For example, during much of the 1980s and 1990s, rebalancing in international and emerging markets equities generally took money out of better-performing domestic stocks and put it in underperforming foreign stocks, retarding the growth of the portfolio. True enough—but only true in retrospect, which is the case with every aspect of wealth management. If we had known that foreign stocks would underperform, we certainly would have avoided them, but that outcome was unknowable. People who claim they know in advance which assets will outperform—that is, market timers—have the worst of all investment track records.
Disciplined rebalancing will, on occasion, slightly hurt our clients' performance, rather than help it. But overall it will help far more than it will hurt, and we want those odds on our side. Most important of all—and it's crucial to communicate this to clients—rebalancing keeps the risk level of the portfolio within the bounds we and the client have already established.