Why Should I Rebalance My Portfolio?

Figuring out your asset allocation is usually one of the first steps in figuring out how you are going to distribute your funds within the capital markets of the investing world. Creating an asset allocation ensures that your investment strategy matches your risk tolerance, investment time horizon, and goals, and that these are in line with your risk reward potential. However, when an asset allocation is not upheld over time with regular rebalancing, you may find that your portfolio had significant gains in one area, which have grown to a point where any shifts in the market could have a significant effect on the entire portfolio. The problem would be if this effect is negative and outside your original risk tolerance. Essentially, rebalancing your portfolio will ensure that your well diversified portfolio is not overly dependent on any one stock, bond, fund, or other asset.

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How often should I rebalance?

When it comes to how often you should rebalance, you may get competing advice. Most advisors suggest rebalancing at least once a year, while others suggest doing so quarterly or when the market has moved into a correction or the value is out of balance by more than 10% in any one area.  Whatever timeline you choose is up to you. There is no right or wrong answer; however, once you create your plan and choose you method, stick with it. Discipline is one of the most important variables for producing positive long-term results. Periodic rebalancing helps in removing some of the emotional side of investing. It will prevent you from trying to time the market; you will not find yourself holding off on buying a decreasing asset waiting for the bottom of the market or riding a bubble to the very top.

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There are cases against rebalancing, as well. When you look at one asset against another you would often have to ask yourself why you would sell off a well-performing asset to purchase one that is not preforming as well. This means that rebalancing your portfolio offers a certain amount of market contrarianism. Rebalancing is, in a sense, betting against the market trend, by selling a little of what has done best lately in order to buy a little of what has done worse. But when looking at it from a technical perspective, if you were rebalancing on a regular basis and you were rebalancing at the height of the market in February of 2020, you would have been selling stocks that were performing extremely well and purchasing bonds. A month later you would have found yourself with an opportunity to sell bonds and purchase stocks at a new lower price than the month before.

When looking at different strategies for rebalancing discuss your options with your financial professional and your tax advisor. There can be different tax consequences depending on the type of securities and accounts you are trading.

Do you rebalance? If so, what is your method?

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

The Importance of Being Financially Diversified With Your Investments

In building an investment portfolio you will need to take several things into consideration. One of these is that investments involve trade offs. There is always a risk that comes with investing our money. One way to mitigate that risk is by diversification. Diversification is the practice of distributing the risk involved in investing across different types of investments, including across different types of asset classes, products, geographical locations, and times. This helps increase the odds of investment success throughout the volatility of the markets. Diversifying your investments allows you to have investments that react differently to similar market or economic events. In this way, diversification helps you get the most out of your investments by reducing the amount of risk that you are exposed to in any one type of class of investment. In essence you should never “put all of your eggs in one basket.”  

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A few ways to diversify your portfolio include:

Asset Class Diversification  

Asset class diversification, or asset allocation, refers to the spreading of the portfolio funds among different asset classes. Participating in asset allocation means having a mix of assets within your portfolio, having a mix will assist in lowering your overall risk exposure more so than would than owning only stocks, bonds, or another single category of assets.

Product Diversification  

Index funds, annuities, mutual funds, life insurance, and exchange trade funds, are just a few products that are available to investors. When you peel back the fancy wrappers of these products, they are all basically a combination of cash, bonds, and stocks. All of these products have their place in most individuals’ portfolios, and very few investors should ever rely on a single asset product. Other asset products include, tangible assets, such as real estate, precious metals, and other commodities, which can contribute to the overall portfolio diversification.

Geographical Diversification

Global diversification often helps in lowering the risk in your portfolio by increasing your exposure to the global markets. By doing this, you allow your portfolio to take advantage of the different countries’ economies, which often concentrate in different market sectors than those domestically. Globalization and inter-connectivity are here to stay and are going to increase. The United States only represents five percent of the world’s population, and, despite having being the world’s largest national economy, it still only accounts for twenty percent of the world’s total income according to the United States Trade Representative. Owning stock and bonds from companies outside of the United States will allow you to have a broader diversification should the United States have an economical slow down while other areas of the world thrive.

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Time Diversification

Look at time diversification as dollar cost averaging. The strategy behind dollar cost averaging consists in making regular contributions of a set dollar amount towards the same fund or stock over a long period of time regardless of the market conditions. When dollar cost averaging is used over long periods of time, it tends to reduce investment risk, reducing average costs per share over time and allowing the investor to purchase more shares in an economic downturn.

Most financial professionals will agree that, although having a diversified portfolio will not mitigate all risk of loss, diversification is the most important part of producing long-term financial gains while minimizing the risk to your portfolio.

How do you protect yourself against investment loss? How do you protect yourself against inflation?

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

What is Investment Risk?

Because investment involves trade-offs, there is always a risk that comes with investing our money. If you hold cash in your mattress, you will never earn interest and risk losing purchasing power to inflation or, even worse, your home being burglarized or burning down in a fire. On the other hand, if you lend someone money there is a risk that the borrower will not repay you when the time comes. Likewise, when you purchase an investment there is a risk that the bank, government, or company may not be able to pay you back or even that it may go out of business, leaving you high and dry.

In general, the greater the risk the investor assumes, the greater the potential reward and the greater the anticipated rate of return we expect. The key is to determine the suitability of various types of investments and how they weigh your logical decisions verses your emotions if and when your investments experience volatility.  Risk is inherent any time we invest our money with an expectation of growing our investment, and risk is characteristic in all business activities over time. Because of this, good risk management is essential when building your investment portfolio. 

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Thinking about financial risk often prompts us to become short-sighted when thinking about where and how to invest our hard-earned savings. When the market is having record days and all-time highs, such as during a bull market, we often become overly confident and discount the real possibilities of a future downturn. On the flip side of that, we often become overly cautious in the wake of a significant market downturn or when there is uncertainty in the economy. Either condition can have disastrous consequences on your investment portfolio over time.  In fact, many investors do not properly gauge their personal feelings of risk. As a result, they lose a large portion of their investment in a sudden downturn, pull their money at the bottom of the market and avoid reinvesting as the markets recovers from losses, causing irreversible damage to their overall financial well being.

When you are making investment decisions, always consider the different types of risk that you may encounter, this will help you in creating an effective strategy where you can balance your logical head and your emotional heart in order to survive the financial ups and downs that come with investing.  Knowing some of the different types of risk is the first step in helping you maneuver murky waters of investment risk.

When experts talk about risk, you will hear them referring to systematic risk, a type of risk that affects all investments, and unsystematic risk, a type of risk that affects some businesses and not others.  Some of the most common types of risk include:

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Market Risk

Almost all types of stocks and bonds involve some degree of market risk. This is the risk that investors may lose some of their principal invested due to volatility in the market overall. This is a type of systematic risk investors’ face. An investor cannot avoid market risk through diversification. Should the entire market fall, all investments would likely decline as well.

Inflation Risk

Also known as purchasing power risk, inflation risk is the effect of rising prices due to inflation, resulting in less purchasing power as time goes on. In savings accounts or other cash alternatives, such as certificates of deposits or government treasuries, you may see that your investment may not keep up with the rate of inflation. The purchasing power of your invested dollar will be less than it was before you invested.

Reinvestment Risk

When interest rates decline, it is difficult for investors to reinvest the proceeds of their investments when they come due in products like certificates of deposits (CDs), bonds, and treasuries or when preferred stock is called by the company, and still maintain the same level of return at the same level of risk. Think of it this way, if you purchased a five year CD in 2015 at an interest rate of 5% and you wish to reinvest your principal and the interest you earned in another CD in 2020, you will be looking at a rate closer to 1% for the same level of risk you took in 2015.

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Credit Risk

Also known as default risk, credit risk involves losing all or part of your principal due to a company or government failing. Credit risk is related to debt securities and varies by product and the credit rating of your investment.

These are by no means all the types of risk you may face, but these are some of the most common risks you may experience.  It is important to know the different types of risk when building your portfolio and how you feel about each to know how you will navigate them before they happen. It is important to gauge your personal risk tolerance. This will help you when it comes to creating a diversified and disciplined investment strategy.

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

The Magic of Compound Interest

Compound Interest is an important concept to understand in helping you build your wealth.  Understanding compound interest will help you understand why it is important to get the best interest and yield on your accounts. It’s not magic it’s math, and it helps you grow your wealth.

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Compound interest is what can make your deposits grow faster, similar to the “snowball effect.” When you roll a snowball down the hill, the snowball continues to grow upon itself and ends up growing so big it becomes a giant avalanche. Compound interest works relatively the same way, earning money on your initial deposit and on the interest that you earned, as well.  This cycle of compounding your investment and the interest that you earn leads to significant increases in the balance over time. The compounding of interest can happen in several manners depending on the compounding period, which can be measured daily, monthly, quarterly, or annually. In most cases interest is calculated on a monthly basis. This is typically the case with savings accounts and certificates of deposits (CDs). When shopping rates, look at the annual percentage yield (A.P.Y.), it is the true rate that takes the compounding into account on an annual basis.

In the example below, the initial deposit is $10,000 with an annual compound interest rate of 5%. The money is left in an investment account for fifty years. After the first year you have made $500 in interest and have a total amount of $10,500. That $10,500 is earning interest the entire second year and now you made $525 in interest with a total balance of $11,025. This happens year after year, and at the end of the fifty years you have $114,674 without ever adding to the principle investment.  That is the magic of compound interest.

Compound Interest AnnuallyTotal
Year 1$10,000 x 5% = $500$10,500.00
Year 2$10,500 x 5%= $525$11,025.00
Year 3$11,025 x 5% = $551.25$11,576.25
Year 4$11,576.25 x 5% = $578.81$12,155.06
Year 5$12,155.06 x 5% = $607.75$12,762.81
Year 10$15,513.25 x 5% = $775.66$16,288.91
Year 25$32,251.00 x 5% = $1,612.55$33,863.55
Year 50$109,213.33 x5% = $5,460.67$114,674.00

Compound interest works in your favor, especially when you are able to deposit funds and leave them to grow. Combining compound interest with periodic deposits to your account, perhaps on regular intervals, helps you build savings for your future even faster.

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Let’s take a look at the magic of compound interest while continuing to contribute to the principle of the investment. We can deposit the same $10,000, in the same investment account earning a 5% yield and compounding monthly. With this example, we add an additional $250 each month to the account. Compounding monthly we will need to divide the interest rate by twelve for the amount being paid on a monthly basis. Because we are earning a 5% yield on an annual basis, we will be earning 0.41667% on a monthly basis. After the first month we would earn $41.67 in interest and deposit an additional $250, bringing the total balance to $10,291.67. Doing this for next five years would result in having an account worth $29,832.11. After fifty years, the account balance would be $788,357.98 with a total contribution of only $160,000 ($10,000 initially and $150,000 in monthly deposits) over the fifty-year period.

Saving $250 Per Month With Compound Interest MonthlyTotal
Month 1$10,000 x (5%/12) = $41.67 + $250$10,291.67
Month 2$10,291.67 x (5%/12) = $42.88 + $250$10,584.55
Month 3$10,584.55 x (5%/12) =  $44.10 +$250$10,878.65
Month 12 Year 1$13,276.02 x (5%/12) = $55.32 + $250$13,581.33
Month 24 Year 2$17,024.96 x (5%/12) = $70.94 + $250$17,345.89
Month 36 Year 3$20,965.70 x (5%/12) = $87.36 + $250$21,303.06
Month 60 Year 5$29,462.35 x (5%/12) = $122.76 + $250$29,835.11
Month 120 Year 10$54,812.29 x (5%/12) = $228.38 + $250$55,290.68
Month 300 Year 25$182,679.29 x (5%/12) = $761.16 + $250$183,690.46
Month 600 Year 50$784,837.82 x (5%/12) = $3,270.16 + $250$788,357.98

No matter how you choose to save for your future, the most important thing that you can do now is to open an account and start contributing to it on a regular basis, whether you’re starting a savings account, retirement account, or a standard investment account, this will allow you to take full advantage of compounding interest rates. The sooner you begin investing, the larger you balances will be when you reach retirement age. Compound interest rates will work in your favor over the long run. 

Tell me your stories and your thoughts by leaving a comment below. Let’s have a better money conversation.

Dollar Cost Averaging to Build Your Wealth.

The strategy behind dollar cost averaging consists in making regular contributions of a set dollar amount towards the same fund or stock over a long period of time regardless of the market conditions in contrast to investing a lump sum all at once. Many of us are already doing this in our retirement plans, as we are setting aside a percentage of our income towards our retirements. That money is then invested in the funds that you or your plan administrator has selected for you inside your retirement plan. This form of investing allows you to purchase more shares when prices are low and fewer shares when prices are high, averaging out the cost of your investment.

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DatePrice Per ShareSharesCost
April 1st$20.0050$1,000.00
May 1st$15.0066.66$1,000.00
June 1st$10.00100$1,000.00
July 1st$1855.55$1,000.00
Average Price Per Share:$14.69

Let’s see how it works. Consider investing $1,000.00 per month over the next four months into a fund with relative volatility. The first month you invest $1,000.00 at $20.00 per share purchasing 50 shares, the second month the price is down to $15.00 per share where your $1,000.00 purchases 66.66 shares, the third month the price is down to $10.00 per share and you obtain 100 shares, the fourth month the price is now $18.00 per share and your $1,000.00 equates to 55.55 shares. In total over the four months you have purchased 272.22 shares spending a total of $4,000.00, dividing the cost by the total number of shares your average price per share is $14.69. See further examples with dollar cost averaging the S&P 500.

Broad diversification of your investment portfolio being one of the most important things that you can do for your investments, think of dollar cost averaging as the diversification of time. By diversifying your investment over a select time period, it reduces the risk that you’re investing at an inopportune period of the market.

If you are thinking that it would just be better having purchased all the shares at the $10.00 value, you are right it would have been. However timing the market for the average investor is a sucker’s game, even with all of the information available these days there is no way to know when the market will go up or down and by how much. Dollar cost averaging may not be the most effective investment strategy when looking for total return verse that of investing a lump sum at one moment but most of the world does not have large cash reserves sitting around to invest in one lump sum. Dollar cost averaging is one investment strategy to adopt to ensure that some of your savings goes to work for you.

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Most importantly, the practice of dollar cost averaging creates a good habit of investing for your future. Every dollar that can work for us in the longer time horizon the more secure we will be in the future when we need the money. Leave a comment below and let’s start a better money discussion.

Put Your Returns To Use

It’s that time of year again and with returns coming in the millions every day so are those returns being sent back to you. With the average return at $3,200.00 so far this year as of February 28th, according to the IRS.gov, what can you do to get your best return on investment with your tax return?  However you approach your tax situation, if you are getting something back this year you should view the money as an unexpected windfall that you were not expecting and put the money to use for you.  Three great strategies include:

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Paying of your high interest debt:

The more debt that you carry, the more money you are taking away from your future self, if that is six months from now or forty years, if you are carrying balances month over month you are depriving yourself of future resources.  Using this year’s tax returns to pay off your high interest debt should be your number one priority. Not only will paying off your higher interest debit provide your future self more financial stability, it could help improve your overall credit score by reducing your revolving available or credit utilization. With a better credit rating you can help yourself to lower loan rates in the future as well. 

Funding your emergency savings fund:

In basic financial advising we learn that clients should establish an emergency savings fund equal to three to six months of their living expenses.  Savings for your emergency fund is one of the most important concepts in financial advising.  Too often, an individual’s finances are ruled by their emotions and biases, we often overlook the boring future of saving for a rainy day when we can get instant gratification (something now). Unfortunately, no one can predict when an emergency situation might pop up, from the car breaking down to a medical emergency of yourself or a loved one; and if you don’t have the money set aside you may have to charge the expense on high interest credit cards or shuffle other bills around so that you can get back to work to pay those expenses off. Putting your taxes towards your individual emergency saving fund is a great idea.

Contributing to your retirement:

Funding your retirement each year is probably the most important thing your can do for your future self financially. Since you are treating your tax return as an unexpected windfall, using that money to contribute to your retirement will have your future self reflecting on how smart you truly are. While rates of return may fluctuate on your retirement account, the sooner you start, the more your money will compound, leaving you a bigger pile of money when the time comes to retire. With so many different types of retirement plans available to you it is important to do your research and talk with a professional advisor or your accountant when starting out to help find the right plan for you. 

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Keeping your long term goals in mind when making financial decisions is imperative, how you plan and prepare for your future is essential to creating a better outcome. Create and follow your budget and set your goals.

Regardless of your approach, tell me how you approach you taxes and your returns. Start a conversation and lets have a better money discussion.