How Rebalancing Adds Value1, 2 – through maintaining a portfolio you can stick with in preparation for the trying times
Marcus Schafer (00:06)
This is going to be episode 22 of Greenstream where logic meets life and investing. What we’re going to talk about today, Pat, is rebalancing. How to think about optimizing your portfolio given your asset allocation target. So this is kind of the third conversation in series of three. We started with maximizing that stock bond mix. Then we added in international stocks. Now we’re thinking about how to balance.
Kind of the stocks, bonds, international US exposure. And I guess the question we are trying to answer is does rebalancing add value and how does it add value? Because I think this is one of the misconceptions out there in the marketplace.
Pat Collins (00:50)
We’re big believers that rebalancing does add value. I think you have to define what value is. That’s going to be an important aspect of why you would potentially rebalance. But I think there’s a few reasons that make sense probably for us to get into on why rebalancing matters, why it’s so important. I’ll just start with maybe the biggest one in my mind.
which is if you have a process for rebalancing, which, you know, just to define it for our audience, I think it’s probably straightforward, but it’s the act of taking your portfolio from, you know, having an asset allocation target and bringing it back to that target at some interval or some level. We’ll talk about the different methods that you can take to get there, but that’s kind of the process of doing that versus just saying, I’m going to let it go and kind of let it do its own thing or
kind of having more of a random approach of saying, I’m just going to buy this and sell that. I don’t have an asset allocation target to it. So I would just say right from the get-go, the biggest benefit I see with rebalancing is the discipline that it brings to the portfolio management process. I just think that if you are consistently rebalancing, whether that be on some time basis or some other metric that you use to trigger a rebalance, it creates discipline.
to make sure that your portfolio is staying aligned with your overall financial plan and your overall asset allocation targets. Most likely you would have created a financial plan that has a required return that can map to an asset allocation, which then should be rebalanced regularly to stay on track. So, you when you think about the process of rebalancing, the last thing I’ll mention about why I think it matters and why I think the discipline part so important is rebalancing occurs when there’s been
kind of movement away from your target. When does that happen? That happens when either the market goes up a lot or the market goes down a lot. And so the process of rebalancing, if the market goes up, what does that mean? Well, if I have a stock bond mix of 60 % stocks, 40 % bonds, that means my stocks are heavier weighting than what my target was. So I’m going to be selling stocks in that environment. If the market goes down, I’m going to be, you know, underweight my stock target.
So I’m going to be buying stocks in that environment. And if you think about the discipline that that means is that I am basically buying low and selling high compared to where maybe the market was, you know, month ago or two months ago or whatnot. So we believe that’s one of the best ways to just stay disciplined is have a process and follow.
Marcus Schafer (03:30)
Yeah, it takes a lot of the guesswork also about, you’re investing cash into a portfolio. You kind of have rules. We’re going to talk about what those rules are, which means it’s more likely for you to invest into the marketplace as opposed to the hesitation of, I don’t know what I’m going to invest in. It kind of establishes the rule process for how you’re going to contribute your new dollars into a portfolio. If you’re taking money out, it’s going to establish
Hey, what’s kind of the hierarchy, the checklist? Again, we’ll kind of walk through that about how you should think about withdrawing to maximize the use of those dollars. And then I think one of the points you made, which was what is the value add of rebalancing? Sometimes people will tell you it’s about expected returns in a market following. I think that could be the case, but I do want to say that over time, we expect stocks to do better than bonds.
So the act of rebalancing from an expected return lens doesn’t really make sense because if you don’t rebalance, you should have higher returns over time. We would look at that and say, well, you misaligned your asset allocation. You misaligned the purpose. Why weren’t you at a higher asset allocation to begin with if you were comfortable with that allocation? So when you look at, when you look at the research, you really have to think about, okay, let’s kind of like.
take expect returns a little bit off. And then let’s look at two kind of considerations, which is when do we rebalance? What’s the cost of that rebalance? A lot of the way the research does is looks at turnover and ⁓ you kind of compare that turnover against how different you are from your target portfolio. So that way you kind of get out of this style creep methodology.
And then if you kind of think about, well, what are some of the ways that you can balance that tracking error, how different you are from your asset allocation with turnover, the cost to actually achieve that. And turnover is a proxy for all these different things. It could be trade fees, it could be taxes, it could be bid-ass spreads. And what the research kind of shows is there’s kind of two major approaches. You’ve got the calendar approach, which says, hey, every year I’m just going to rebalance my portfolio.
And then there’s more sophisticated approaches, tolerance and tier tolerance, like we kind of think about.
Pat Collins (05:56)
Yeah, there’s a lot of like nuances when it gets into rebalancing. And I think we’ll get like more into the weeds on this. You made a really good point about the idea of does this really add value in the traditional sense that I think people think of value, which is increased by returns. And I’ll tell you that one of the ways I think we look at it is, and we’ve gone back and look to see when does, because the answer to that is it depends. There are periods for sure where rebalancing adds value in the means of higher expected returns.
Expected Returns – rebalancing is most likely to contribute to returns in significant market declines
But over time, I totally agree with you that it should decrease expected returns because we’re basically going to be selling the asset class that has historically had better returns than the other. But if you think about it from a planning perspective as a client, let’s think about the two scenarios. So when does rebalancing add value? It’s when the markets are going down or very choppy. the three periods that we extended periods that we’ve researched where rebalancing really adds value is the Great Depression,
There was 10, 15 year period there where the market basically went straight down and then came back up and it was choppy in between too, but a long stretch where if you were investing, you weren’t making any money basically if you just were a buy and hold investor. There was a period during the 1970s where we had really high inflation and the market basically chopped around for a long time and just ended up going nowhere for over 10 years. And then we had the period from 2000
to the end of that decade where you had the beginning of the decade being the tech bust and then the end of the decade being the financial crisis, another period where you had ups and downs in the market. But when you started to kind of look at it over a 10 year plus stretch, you realize you didn’t really make any money. So in those in every one of those environments, if you were rebalancing each year, you you think about what was happening while the market went down. We would be selling bonds and buying stocks to get back to our targets.
you get in this place where when you look at it after the year of my two scenarios of do nothing versus rebalance, it made, had more value. I made more money if I rebalanced during those choppy stretches. So that’s the one scenario.
Marcus Schafer (08:10)
of the worst case scenarios is when you see a lot of the value being added.
Pat Collins (08:14)
That’s the key is because this the alternative is where I don’t get at value add is when the market’s going up kind of like straight up kind of like a period we’ve been. But if you still look at your portfolio, you are meeting your goals most likely because you are doing very well. You still have a healthy weighting in stocks. You’re just not going up at the level of the stock market. Maybe the stock market’s going up at 15 percent and you’re only going up at 10 or 11 or 12.
you still probably can meet your goals. So there is a smoothing effect that this does with rebalancing where, yes, when the market’s going straight up, you’re probably getting a little slightly lower returns because you’re rebalancing out of stocks. But when the market is choppy and going down and popping back and forth and whatnot, you’re probably getting higher returns. And so you get this a little bit more smoothing, which is much more valuable in the planning process when we’re trying to plan for someone, say, retirement withdraws. We don’t want to have big ups.
big ups and downs. want to have smoother returns.
Rebalancing Strategies3 – tolerance band rebalancing is more efficient than calendar date rebalancing when comparing turnover with tracking error
Marcus Schafer (09:14)
Yeah, that’s super, super interesting just to think about those worst case scenarios versus the best case scenario. And what are we trying to plan for is probably how to react in the worst case scenario. Cause on a relative basis, that might be a little more impactful. And yeah, I jumped into the, to the nuance of rebalancing. Let me just set the stage a little bit. When you look at the research, the difference between some of those approaches I was talking about calendar versus tolerance band.
It’s probably 10, 15, 20 basis points of expected return difference kind of between those approaches. And for a calendar year, you could do once a year, once a month, once a quarter. But essentially, the more often you trade, you’re going to be increasing costs. what you’re trying to do when you rebalance a portfolio is you want to rebalance with the lowest cost.
And then you also want to rebalance in a way that best repositions your portfolio relative to the asset allocation. So calendar rebalancing, I don’t think it’s bad in any way. It’s maybe about 10 basis points less efficient, but a lot of like, if you look at inside a 401k and you say, Hey, how do you want to rebalance? It’s going to essentially say, do you want to redo this once a year?
Whereas somebody like us who we’re kind of looking at this stuff every single day and using systems and focus to do it, we’re going to be more tolerance band oriented. And so Pat, maybe, maybe it’d be helpful to just explain what tolerance band is.
Pat Collins (10:51)
Yeah, the, in the, in the kind of continuum of rebalancing, I would say on the one end, have no rebalancing, which is the worst scenario. Then you move on to calendar rebalancing, which is better than nothing. So it’s, it’s good. You will, you know, the time based, basically it can be quarterly calendar year, but basically it’s just something automated or you just set a reminder of yourself, go in, rebalance the portfolio on this date. I’m not going to look at anything else. That’s all, that’s all I’m going to do. And then the other way, which is how we’re doing it, which is.
tolerance bands were basically saying we will only rebalance a portfolio when it gets outside of some stated tolerance that we’re ⁓ using. I’ll go back to our 60-40 portfolio. We might say if it goes past 65 % equities, then that’s a trigger for us to rebalance the portfolio. And the reason you would do that is, again, to your point of lowering costs. If I have a portfolio that every year it’s just going to rebalance on one-one.
and I’m at 63 % equities, there’s a cost to do it. You have to weigh that. And so it could be tax costs, there could be other trading costs involved. And so just to trade because it’s a certain day of the year to us doesn’t make much sense. What you really care about is how far away am I from the target of what I’ve set? So it does take more work because you have to monitor the portfolio.
basically all the time. that’s, know, we have technology here that does this on a daily basis to monitor it. So we believe that’s the better way to go, but it does require some more time and effort to go into it. And yes, it probably does add some value over time to do that. The one last thing I’ll mention with that is we’re making it very simplistic in a, a stock and bond mix, but
There’s a lot more levels to it that you have to start to think about. So if you have a properly diversified portfolio, you may have three or four, 10 different asset classes within your stocks. You might have U.S. large cap and small cap. And you may have international emerging markets and value and growth and all these different things. So at the high level, yes, you want to be in my example, 60 percent stocks and maybe the 65th percentile is when you rebalance.
But what happens when you have one of those sub-asset classes that grows a lot and maybe the others are shrinking, for example, you’re still within your tolerance bands at the equity level, but your sub-asset classes start getting out of whack. So we have a way we think about that. have tolerance bands at the sub-asset classes and at the asset class level. Asset class level always takes precedent. And then sub-asset classes are kind of next. The last thing I’ll just mention.
And there is not a right answer for this is what should your tolerance band be? That’s kind of a preference that you need to think about. The wider the band, the more variance you’re going to have from your target. So you’re going to have a lot more kind of volatility with the portfolio. Most likely you’re going to have less costs, which is probably a positive for making sure the bands are wide enough. But
you will have more potential losses and or gains in the event of market movements because you’re just going to let the portfolio run a little bit longer. a portfolio that is 70 percent stocks is going to be more volatile than a portfolio that’s 63 percent stocks, for example. So if you’re not rebalancing, you’re going to just see more volatility. You have to be OK with that. Those are kind of preferences you have to you have to decide.
Marcus Schafer (14:30)
Yeah. And the tolerance band, one thing that’s super helpful about that is it kind of makes sure that you’re out of this de minimis spot because the worst thing, if you’re 60 % equity, it actually doesn’t take that long for the market to move you to 62 % equity compared to bonds. Given volatil, that could just be a week. So if you set it too tight, next week it could drop and it could go back down to 60. So that’s why we just try to think about
having a rule-based approach, but giving some flexibility, just given volatility, and then thinking about each asset class, what’s the volatility, what’s the likelihood that I’m going to trade at the wrong time? And it’s just market noise because markets are way noisier than most people think about.
Rebalancing Goes Against Instinct – which is why having a policy is crucial
Pat Collins (15:20)
It’s a good point. you know, portfolios do move around quite a bit, especially the equity portion of your portfolio. So if you have a very tight band, it’s going to require a lot more trading, a lot more monitoring. The one other thing I would just say that I’ve seen some investors make, you know, make a mistake is they have this plan and they don’t follow it because rebalancing really goes against all the instincts that you have in your body. Usually, if you’re doing it the right way, which is
Market is tearing higher. You’re like, wow, why do I, do I really want to sell this? It’s done so well. Do I really want to sell Nvidia? It’s gone up so much. Why would I trim this right now? I don’t want to pay the taxes. What do you, I have lots of justifications for it? You see that decent amount on the way up. I really see it from investors on the way down. I remember in 08, we followed this approach and I remember getting calls from clients.
Because we have discretion, we trade portfolios based on an investment policy that every client has to stick with the target. And when the market dropped 50-ish percent over the course of 08, 09, in the midst of that, we were selling bonds and we were buying stocks. And I remember some of the calls saying, I can’t believe you’re selling the only thing that seems to be working for me right now. And you’re buying the thing that looks the worst.
Why would I want to do that? And you you go back in time and you say, well, those are the best trades you ever made in your life. You’ll never see prices like that again. But in the midst of it, it is really, really hard to follow it. So having a rebalancing policy makes a ton of sense. People probably listen to it go, yeah, that makes sense. We should do that. It’s easier to do in theory than it is in practice because you have to deal with the emotions that come with losses and gains in the midst of really tough markets.
Marcus Schafer (17:13)
Yeah. And for somebody like us, it’s kind of why advisors at Max work with about a hundred people, because not only do you have to do those trades, if you think back to code, I can’t remember how many days of a drawdown, 20 days of a drawdown you have to make these, all these different trades, in many cases, multiple trades, because it’s on the way down. But you also have to make sure people are super comfortable with an understanding of what’s happening. What are we learning about asset allocation?
What are we learning about risk tolerance and risk preferences? So it’s kind of balancing those two things. And if you’re left to your own devices, that’s maybe where you might think about a dedicated asset allocation fund that’s going to kind of make those decisions for you that loses some control. But also if you’re working with an advisor, just making sure you’re aware and you’re comfortable with what’s going on. And I think the other balances that we run into is also
Reasons vs Excuses in Exercising Judgement4 – taxes add or reduce rebalancing costs
There’s a lot of reasons why, to your point, Pat, it’s a tough line between a reason and an excuse for why you might not make a trade, right? And for instance, we might look at a situation right now, it’s getting towards the end of the year. We might be thinking about somebody’s tax situation, say, hey, it would be really unfortunate if we were to sell equities because they’re outside of our tolerance band a month before somebody’s capital gains budget can kind of reset.
And next year, they might be in a lower capital gains bucket in terms of taxes. So, it’d be, I don’t know, we’re trying to work with them to figure out, just pushing this trade a month, is that actually going to be more efficient for the client? And again, just having outside perspective to think about reason or excuse, I think is helpful.
Pat Collins (19:04)
I think we’ll kind of walk through the ideas of how we think about rebalancing in practice because, you know, it’s one thing to say, it’s time for me to sell stocks and buy bonds, but then how do you think through it is going to be really important. But I do want to touch on your point of if you’re working with an advisor, I believe this is an important aspect is making sure that they have the time and resources to think through those.
those things. the issue with it is, and this is maybe a little bit of inside baseball for people listening, is that when we rebalance a client’s portfolio, it’s almost always everybody’s portfolio is being rebalanced at the same time, because the market is doing the same thing to all of our clients’ portfolio at the same time. So COVID is such a great example where it was the most, more than 2008 for me, and more than 2000.
It was the most intense period because of the magnitude of losses in such a short period of time. So if you were trying to rebalance portfolios, you had to be looking at it daily. And if you had 250 clients, there is no way you could have kept up with what was going on during COVID. We were all hands on deck. Our average client ratio is probably at the time was 60 or 70 clients or so per advisor.
And we were every single day dealing with trading because again, when it, when it keeps dropping like that, you are rebalancing pretty, so, you might rebalance two or three times throughout that. And then you have 60 people you’re doing that for. So just maybe a little bit of a something to think about for investors and for our audience is if you’re looking for someone to do this effectively, in my opinion, this, that’s one of the most important things is do they have the bandwidth to do it? And that means client, you know, client caps or.
numbers of clients per advisor, because this all happens at once for the most time for a firm. It doesn’t happen like, I’ll rebalance this person today and I’ll rebalance this client next week and I’ll rebalance this client. If you’re using tolerance band, the market moves all at the same time and that requires you to have some nimbleness there.
Marcus Schafer (21:15)
Before we jump into, we’re kind of talking about the extreme case, and then maybe I think it’d be helpful to talk about day-to-day kind of normal market environments. How do you think about this stuff? But while we are on kind of these extreme cases, maybe it’d be good just to talk about tax loss harvesting, especially in an environment where, again, tax loss harvesting, when investment drops in a price below what the cost basis is, you can sell that investment.
and you recognize the tax benefit and why the government sets this up is they want to encourage investment. So they don’t want you to be discouraged if one particular investment loses money. They want to allow you to recognize that as a tax benefit and keep you as an investor. And there’s some rules around that. But when markets are dropping or a asset class is dropping, that’s another reason why there might be trading. And oftentimes it coincides with a rebalance, but sometimes
but sometimes not. So maybe just talk a little bit about tax loss harvesting.
Pat Collins (22:17)
Yeah, it’s fairly simple. It’s the idea of selling an investment that’s gone down to harvest or, you know, kind of retain this loss that we can use against future gains. When you think about it, really what it is, is it’s a tax deferral strategy for the most part. I mean, there’s some ways that you could almost, you know, we can talk about how it can be a tax avoidance, but it really is a tax deferral strategy because if I buy a stock for $10 and
you know, or a fund, let’s say US stocks for $10 in some sort of ETF or whatnot. And it goes down to $6 and I sell that. I don’t want to necessarily get out of US stocks. I just want to recognize the loss. So what we do is we would say, well, let’s just sell that particular US stock fund and put you into another US stock fund, just reinvest the proceeds into something very, very similar. And by doing that, we still have $6 in US stocks.
It’s just now we have this $4 loss we can use against gains in the future. So that sounds great. Obviously I have this loss. I can avoid paying taxes. But the other thing, the other side of that to remember is that I now have basis in my new stock fund at $6, not $10 anymore. So I have a bigger future tax liability. But as an investor, I would prefer to get all my tax benefits now.
versus in the future, it’s just time value of money. I want to get the money in my pocket now and I want to pay taxes later if I can. So that would be kind of the thought process. But in the context of rebalancing, this is another part of it is when you’re rebalancing a portfolio, what we’re always looking at is are there opportunities to tax loss harvest so that we can build up a pot of losses that can be used against gains in the future?
Marcus Schafer (24:09)
Yeah. And if you go back to that COVID example, if you’re investing in something, a primary position, right, something we recommend, well, we recommend it because we think it’s the best investment in the asset class. That’s why it’s recommended. So by definition, the next investment is not as good and it can’t be the exact same strategy. It must be a little bit different. But then this also gets into why some of this stuff is helpful because COVID
You don’t know the top and you don’t know the bottom. So you’re kind of doing this process on the way down. But I was working with, in my last job, advisors that would do this four times on the way down. By the fourth trade, there’s something called you can’t reinvest in your original thing for at least 30 days. So by the fourth trade, how good is your investment product that you’re investing in compared to your original? I think that’s also something you can’t just go about.
these processes blindly, you have to really be thinking about the trade-offs and trying to balance after-tax expected return for the big picture, which is really tough because it’s easy to break things down to components. Hey, this is a basis point more expensive. That tells me a little bit about future returns, but ⁓ not the whole picture.
Pat Collins (25:31)
COVID was such a weird time for investing, but I remember having an emergency meeting of our investment committee because of exactly what you said. had gone through two, like we typically have for every investment, we have a swap alternative for tax sales harvesting. And we had gone through that. were hitting our third one because we couldn’t reinvest back into that original one because it hadn’t been 31 days yet. So ⁓ it was a strange time for sure. Maybe we can talk a little bit about
you know, kind of some of the processes or thought processes on how to actually go about doing this. So hopefully we’ve convinced everybody, yeah, it probably makes sense to rebalance my portfolio. Maybe you can make a decision on calendar year versus tolerance bands based on your preferences there and how much time and if you’re using an advisor or not. But then it comes down to, well, like what practically how do I do this? So I think there’s there’s two elements that maybe we could talk about. One is, you know,
Using Cashflows to Rebalance – is most efficient, whether through dividends, distributions, contributions, or withdrawals
There’s kind of, we were talking about this earlier, there’s two elements of like how a portfolio is kind of being managed. So there’s one where no money’s coming in or out of it. It’s just, I have this money, I’ve been managing it. It’s there, it’s going to go up or down. And so when I do rebalance the portfolio, I got to sell something to buy something. Basically there’s no extra cash sitting around that I’m putting in.
The other scenario are clients that are putting money in or taking money out regularly. And that creates an opportunity to rebalance. So I’ll start there because that’s the easiest one. The easiest scenario by far is if you are adding to a portfolio because all of your new contributions, you can just do, it’s a math equation. You can just go in and figure out where am I underweight? That’s what I’m going to use to rebalance the portfolio. There’s no friction, no taxes. Yes, I have to buy something, but
I don’t have to sell anything. can just use all my new money to rebalance the alternative of I either have to say, know, I’m, taking money out of a portfolio. So this would be like more of a retiree scenario is now I have to make some decisions. can use the outflows to rebalance, meaning whatever’s up. That’s what I’m going to take from. But it’s not always that simple. You know, is it if something, if I’m 60, 40.
is my target and I’m 61 % stocks and 39 % bonds. And that 1 % extra is going to cause a big tax hit if I go to use that to rebalance. Do I want to do that? Or should I take from bonds? They’ll stay within my tolerance bands. Those are kind of harder decisions that you have to think through as an investor.
Marcus Schafer (28:11)
Yeah. And on the accumulation where you’re adding to a portfolio you’re contributing, we think it’s easy because we have these rules-based processes. We look at it and we say on a relative basis, here’s what I want my exposure to be and here’s the asset class that hasn’t been doing as well. So we think that’s an opportunity to, in a sense, buy low. We still get a lot of questions from clients and prospects. Hey, I’m making a little more money. I have a little more money this year.
How should I think about investing that? For us, it’s easy because you have a rules-based approach. If you don’t have a rules-based approach, it’s not an easy conversation because you don’t know from an expect a return standpoint where is the best place to put my money. This is one of the areas where doing your work ahead of time, I think is really powerful down the road because it simplifies a lot of the carry-on investing. ⁓
investing decisions. In that other portfolio, since you were talking about, there’s still an opportunity to rebalance, even if you’re not adding money or money coming out of it. And that’s by instead of automatically reinvesting dividends, take those in cash. This is very simplistic, but one trade is better than two trades is essentially the whole idea, which means anytime you have cash in a portfolio gives you an opportunity to rebalance.
So distributions from dividends give you an opportunity to rebalance. If you’re unfortunately in some legacy mutual funds that have big capital gain distributions, we still see a lot of those. They distribute in up markets and down markets. It’s just kind of a weird structure of the mutual fund format. But that’s an opportunity to say, hey, I don’t have to reinvest in something that’s tax inefficient. I can take that in cash.
$20k to Europe Case Study – how we think about the checklist of raising cash in a portfolio that results in extra costs
So I’d say those two things and then Pat, maybe it’d be helpful just for somebody to like, let’s just role play and, hey, Pat, I want to take $20,000 and go to Europe. What type of decision tree is an advisor thinking about to make sure we get that money in the most tax-efficient way possible?
Pat Collins (30:28)
Yeah, I’m going to start at the very beginning of how somebody should think through that because it’s a really great question and happens all the time. So first is, is this in alignment with my financial plan? So this probably even more important than the rebalancing discussion is I’ve set up. Hopefully, if you have a financial plan, some sort of spending plan, here’s how much I expect to spend. Is it in alignment with that or is it way off? And if it’s way off, then there should be a discussion of do we need to change our plan?
But let’s just assume you can check that box. Yes, I was planning on going to this trip, on this trip. Yes, I was planning on spending this money. Check that box. Okay. The next is where am I from a target allocation standpoint compared to what my plan says? So my plan has a certain return that’s required. We’ve mapped that to an asset allocation that we think has a high probability of achieving that return. So how far off am I from my target?
And if we’ve been using this example of 60 40, so am I exactly on 60 40? Am I at 62 38? Am I at 70 30? Maybe I am. Maybe I’m pretty far off my target. So that would be the next kind of decision point or thing that you want to look at is where am I compared to my target? And then it comes down to how do I execute on this? So let’s just assume because almost in all cases you’re going to be off target, but they all you’d want to look at. Am I inside my tolerance band?
or outside my tolerance band. If I’m outside my tolerance band, fairly simple in our opinion is you place the trade to get you closer to back to your target, irrespective of taxes, typically. we want to over, if I have to put a order of operations, if you will, on things, first is we want to make sure our portfolio is in alignment with how much risk we’re willing to take. Second would be to optimize for tax. So if we are outside of that band of risk, then we want to try to get it closer.
And then, then you kind of get into, let’s say, you know, so that becomes a fairly simple conversation. But the other one would be I’m inside my tolerance bands. What do I do now? So now you’re starting to look at tax optimization for the portfolio. So are there tax losses I can take to offset anything? You know, are there other things I can do? Which account do I take it out of? So I have an IRA.
I have a taxable account. Do I want ordinary income this year? Do I want capital gains? you know, normally you want the thing that’ll generate the least amount of tax, but not always. If you’re in a really low bracket, maybe you want to generate higher taxable income because you’re not paying much in income taxes this year. So something simple like what you said of I need $20,000 to go to Europe, that is there is a multiple kind of levels of decision making that has to be thought through to do it well.
And to try to optimize that. And we’ve always said, you know, we want to basically try to make the best decision possible with the information that we have and do that every, you know, over a long period of time, we know that our clients are going to be in a very good position. If we do that, it may not always work out perfectly every single decision, but over time, we feel like if you make good decisions, you will eventually get good outcomes. So anyways, that that’s probably the, the, the thought process that we have going through it.
Marcus Schafer (33:48)
think that’s super helpful because again, like we kind of do this all the time. So I think it’s pretty easy for us to go through that checklist. But if you’re not doing this all that time, you would hate if you can take the money and go to Europe, you would hate for it to become a friction in your life that’s present, that’s preventing you from having fun on that trip to Europe. I’m going to Europe, as you know, in like three days. So this is a little.
Little hot on me. What about the opposite end? Because I do, I think maybe there’s some oversimplification I mentioned earlier, but you you’re working and you say, hey, I actually think I want to contribute more. I have more excess cash. What’s kind of the thought process there when it comes to maybe some of the different accounts or some of the deeper level thinking we might do with somebody that everybody should be thinking about.
Next Best Dollar Case Study – how we think about the checklist of identifying the where contributions add the most value to a portfolio
Pat Collins (34:42)
Yeah, it’s similar. There’s just some nuanced differences to it. So one, I would start with the plan and say, is this savings in conjunction or in alignment with what our plan says for how much we’re going to be adding to the portfolio? And let’s just say it’s not. Let’s say it’s more than we were expecting. We were expecting to save $50,000 a year, and you’ve been consistently putting $100,000 a year in. mean, great issue, obviously.
But I would start there and then that would potentially have us revisiting our asset allocation or at least a conversation about it to say, do we, can we, can we afford to take more risk now? Or conversely could be the other side of that point is we have enough, you’re saving so much more. We don’t have to take that much risk to achieve your goals. And that again comes down to preference, but that would be number one. So that’s, that’s the irrespective of the rebalancing, but that would help us decide, is this the right target that we’re
rebalancing back to. Let’s assume it is. Then at that point, obviously, whatever we’re underweight in is what we’re going to look to buy. But again, we’ll also look at which accounts should we be buying it in? Are there other factors around like future outflows or inflows that we should be factoring in? Typically is, you know, if somebody is putting enough money in, you’re probably buying a little bit of everything. It’s not like one thing you’re buying a lot of times. Hey, I’m putting in a hundred thousand dollars.
Usually it would be like, well, you’re you’re $30,000 underweight bond. So you’re going put a little bit more in bonds, but you’re still buying stocks. It just might not be at that 60 40 split that we were we’ve been talking about. So but that that sometimes is hard for people because you’re buying something that hasn’t done well if you’re rebalancing the right way. And most of the time, people don’t love the idea of that. But again, make the right decision over a long period of time. You’ll get good, good outcomes. You’ll smooth the returns out, which is, one of the big
benefits of rebalancing.
More Positions Increases Complexity2 – but the benefits depend on your tax situation
Marcus Schafer (36:41)
That’s well said. know, sometimes I think, Hey, if all this sounds like super complicated, one of the other decision points is the more individual, the more individual investments you have, it increases in complexity, exponentially, right? And there are solutions out there where you kind of give up some of the control to do tax loss harvesting and sub-asset class levels. Maybe a home bias that
you liked or you preferred, there’s options to give up a little bit of control and just go with a one-fund solution or something like that, that, you know, this is one of the great things about target date funds too, and managing that stock bond mix where if it’s not a taxable account, hey, listen, I don’t want to do all this. I want somebody to do it for me. And every single investment is doing this, these rebalancing for you.
In a sense, I would say the more you break it, maybe we’ll just spend a few minutes talking about more vehicles, what that does for flexibility, but also the exponential challenges.
Pat Collins (37:54)
Yeah. So again, you can kind of be on a continuum here. I’d say what you mentioned probably on the one end would be something like a target date fund where it can perfectly fine for a lot of people, especially if you’re not working with an advisor. It’s kind of a do it for me type of approach. They’re going to set your asset allocation for you. They’re going to rebalance for you. It’s all going to be done internally. Is it optimal? Probably not most likely, but it’s better than
It may be the alternative of not knowing what to do. So I think it’s a kind of a good step as you as you move along. Obviously, you could you can break out that target date fund idea into different asset classes and different investments. And the more you break it out, the more opportunity you have to rebalance because not everything and especially more opportunities you may have to tax loss harvest as well, because the more kind of that you break it out, the more opportunities you have to rebalance it, the more opportunities.
one of those things or maybe multiple may go down in value. you know, instead of having a target day fund, you might say, I’m going to buy a US stock fund and international stock fund and emerging stock fund and a bond fund. Well, now you have four different investments. They may not all go up and down at the same time. So you’re to have to be on top of rebalancing that. But you also have opportunities to tax loss harvest so it can save you in taxes. There is kind of another iteration of that that has become, I’d say, more popular over the last
10-ish years maybe, maybe a little bit longer than that, but where I think technology has gotten to a point where it’s allowed us to say, let’s take that even more to the extreme to say, instead of just owning a U.S. stock fund, we’re going to own all the U.S. stocks that make up this fund. Some people call this like direct indexing or separately managed accounts. But the idea there is I’m kind of doing this on steroids for mostly for the purpose of tax loss harvesting.
where I’m going to own the S &P 500, but instead of owning it inside of a fund, I’m going to own all 500 stocks. And I know after a year, even when the S &P goes up, there will be elements inside the S &P that will go down some individual stocks that I can use to tax loss harvest. So this is kind of the continuum. in the far kind of the, in the cases where it’s like a target date option, all the rebalancing is being done for you.
If you get all the way to the other side of that, where you’re really breaking it out into very, very individual components, that’s where either you or an advisor need to be much more engaged to make sure that A, it’s being rebalanced and B, you’re optimizing it for tax losses.
Marcus Schafer (40:32)
Yeah. And what we’re trying to think about is just what’s the right spot on that spectrum for every individual based upon their unique needs and co-mingled solutions, mutual funds, ETFs, mutual funds, if done tax efficiently in taxable accounts, ETFs kind of mostly have these taxable benefits. But when they, they can essentially rebalance for you because all the other investors of those funds
When they’re buying and selling, these investment managers should be using those cash flows to better position the portfolio. The more you break down the components of that, the more you really have to understand exactly what’s happening. There’s a lot of different small cap funds. If you break that out as a separate asset class, are you sure what you’re buying when you’re buying it is really small cap? And even with the index solutions, that’s not exactly clear.
But I think, you know, examining the spectrum and especially not over-emphasizing tax benefits, if it’s not going to apply to your unique situation, right? So if you don’t need a lot of losses, you might not need the extra complexity that honestly makes a lot of the other rebalancing much more, much more difficult. So I just think figuring out what’s the right balance in terms of number of funds and sometimes
less funds, people might think, that seems less sophisticated. Not necessarily. That might actually be a much more efficient total return approach compared to more funds with less efficiency. And there’s research that kind of backs that point as well.
Pat Collins (42:19)
There’s one last thing on, I would call it the practical implications of rebalancing that I want to just touch on. And that’s the idea of, again, this might be getting in the weeds, but hopefully the people that listen to this, if they’re into this, they might enjoy it. It’s, should you be rebalancing at an account level or what we call a household level? So what I mean by that is, let’s say my wife and I own three different, four different account types. We have a joint account.
Account-Level vs. Household-Level Rebalancing – to tax optimize your portfolio
that’s fully taxable and all the dividends and interest that we receive. We both have an IRA account that’s tax deferred until we take the money out. And let’s say she has a Roth IRA, which is tax free, all of the growth in it. So each one of them has different tax characteristics, basically. So one approach, which is the account level rebalancing, is each of my accounts has its own asset allocation and target. And I rebalance each account back to that. my joint account,
has a 70-30 mix, my Roth IRA has 100 % stock mix, my IRAs have a 50-50 mix, and so I am just looking at each account and rebalancing it back to its target. So that’s one approach, obviously, to look at it. The other approach is household rebalancing, where I say, well, all this money is all gonna be used for the same thing, which is maybe my own retirement. And so I would like to have, on average, about a 70-30 mix, but…
Let’s look at what creates the best tax optimization in my portfolio. And so it might be that, yes, I want to have 100 % in stocks in my Roth and maybe I want to have lower equity weightings and more bonds in my IRA because my IRA, I don’t have to pay tax on bonds generate interest income. I would use it for that. Maybe more stocks in my taxable account. But so when I, if I looked at every individual account separately, they may look kind of weird.
But when I put them all together, they come up with a 70 30 mix. so this whole idea, people call it asset location and it’s really around tax optimization, but it does impact how you rebalance. If you do the household rebalancing, I will tell you the level of complexity goes up significantly when you have to start rebalancing, especially when you’re taking money out, you know, or you have to just rebalance a stock bond mix, because then the question is, well,
Not only do I have to, for example, stocks are up, I have to sell them and put it into bonds. So now I have to think through, ⁓ A, do I want to make that trade to rebalance? But now, two, which account do I want to do it in? Because I have stocks in different accounts. And it’s probably a whole other episode to get into on how you think through those kind of options. But I would say there is a…
You know, there’s different, I guess I’ve seen different research on this as far as the actual value added by doing it this way to try to save an after tax, you know, create higher after tax returns. But it’s something for listeners and the audience to think about is, okay, am I going to do this at the account level or am I going do this at my overall household level with all of my accounts?
Marcus Schafer (45:28)
I think two of the big decision points leading into that is it’s kind of legacy. What does your asset mix look like in the accounts going into that conversation, right? If you don’t have that many different accounts, that makes it easy. ⁓ Legacy positions make it more difficult trying to think about working around those, especially in taxable accounts. So it’s kind of, the answer might be very personalized to an individual.
Which kind of gets to this point around, you should probably have a consistent model portfolio, but the path to get there is going to be very different person by person, given the types of accounts, how the assets split, legacy positions, things like that. Working their way through as you work to rebalance maybe an incoming portfolio into the steady state portfolio and just trying to think about how to smooth that ride over a
over time and get you into a better spot.
Pat Collins (46:29)
The one other comment I’d make on that. again, this is kind of the practical how to think about it or things to consider. One of the things I almost know for sure is when somebody comes to see us and a prospective client and they have a kind of this, you see this all the time, they have accounts all over the place. They have accounts at brokerage firm A and then that old 401k. And then they have this over here. There’s almost in no cases do they have an actual asset allocation plan that is being rebalanced because
just having consolidation of your accounts is one of the key things, or at least a 360 view of what, how much you actually have in stocks in any given day. That’s really hard for a lot of people to answer because they have things everywhere. So you’d have to go pull all those statement values or go on to online, look them all up, figure out what the stock bond mix is on each one of them, aggregate it. So I would just say where possible. think a lot of times people think, well, I like having the diversification
of having different things all over the place. There’s enough options out there now where, you know, whether it’s a Fidelity, a Schwab, all these different investment firms, you can own T-Row Price or you can own Dimensional or you can own American Funds or Vanguard at any of these places for the most part. So I would just encourage people, consolidate your investments. It’s going to make this process a whole lot easier to know what you have, because if you have to manually go out and grab all this data, you’re probably never going to do it. Or if you are going to do it, it’ll be once a year.
Marcus Schafer (47:59)
Yeah. Any other closing thoughts for you?
Simplicity is Elegant – and our next guest
Pat Collins (48:03)
This is the third in our series of portfolio management. Hopefully, what people have learned over this full series is there’s lots of thoughts that go into this. of going back to the continuum theory, like you can simplify it as much as you want by using kind of prepackaged products and really trying to make it as simple as possible. levels of complexity you can add to it. Just be careful whenever you are adding complexity, is it adding value?
And if so, is the juice worth the squeeze basically for people? So I would just be thinking through whether it’s, you know, how you’re thinking about your asset allocation, how to add an international versus US, how you rebalance. All this can be done pretty simply, or it can be, you can add some complexity. We kind of look at it as if it’s going to add value to our client situation, we’re going to figure out a way to do it.
If you’re an individual investor that this isn’t your full-time job and you’re just not looking to do this, and you don’t want to hire an advisor, think about, are there ways I can simplify this?
Marcus Schafer (49:06)
Simplicity sometimes is really elegant. If you think about a duck swimming across the water, super graceful on top, lot of furious kicking ⁓ below the waves there. That’s a lot like how your portfolio should be. It looks easy, you could stick with it. You don’t have to think about it, but there needs to be that compliment to keep you moving forward. With that, well, I guess Pat, do want to tease our next?
Our next guest, before I forget, you did make a reference to inside baseball earlier.
Pat Collins (49:40)
That was on purpose. Yes. We are really excited to have Katie Greggs, the president of the Baltimore Orioles is going to be our next guest on the podcast. She is kind of in charge of all the business side ⁓ of the Orioles organization. She’s come from different ⁓ organizations as well. So she has some experience with other franchises. I am
So excited to get into the business of professional sports. Many of you know, the Orioles have a new ownership team over the last couple of years here. So we’re excited. You know, I think if you are an Orioles fan, number one, you’re going to be want to listen to this podcast. If you’re just a sports fan or business fan in general, I want to understand more about the business side of how decisions are made inside of franchises. It’s going to be fascinating. So I’m really excited that she’s going be on the podcast.
Marcus Schafer (50:31)
Yeah, she is so smart. So we’re lucky to have her.
Pat Collins (50:35)
Great. All right. Well, happy Thanksgiving to everybody.
Sources:
1 Opportunistic Rebalancing: A New Paradigm for Wealth Managers (Daryanani, 2008)
2 Rebalancing and Returns (Dimensional, 2008)
3 Hong, Xing, Portfolio Rebalancing: Tradeoffs and Decisions (2021): https://ssrn.com/abstract=3858951
4 Are Advisors Worth Their Fee | Greenstream 13 (2025)
Greenspring Advisors is a registered investment adviser with the SEC and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. The social media platforms associated with this name are solely for informational purposes and do not offer advisory services or sales of securities. Investing involves risk and possible loss of principal capital. Comments by viewers and/or recognitions are no guarantee of future investment outcomes and do not ensure that a viewer will experience a higher level of performance or results. Public comments posted on this site are not selected, amended, deleted, or sorted in any way. If applicable, certain editing of personal identifiable information and misinformation may be deleted. Content may be dated. Links to third-party sites, or information is from a reasonably reliable source. Information presented on this program is believed to be factual and up-to-date, but we do not guarantee its accuracy, and it should not be regarded as a complete analysis of the subjects discussed. Discussions and answers to questions do not involve the rendering of personalized investment advice, but are limited to the dissemination of general information. A professional advisor should be consulted before implementing any of the options presented.