Barron's had an article about rebalancing portfolios noting that the run in stocks was a good time to rebalance the equity allocation back down closer to target, whatever that might be and also rebalance down some of the relative winners. Regardless of anything to do with rebalancing, if you use a broad technology sector ETF for that exposure, it is probably close to doubling up on the S&P 500's return in that time and if you use individual stocks and were lucky (or skilled) with your picks you could be up much more in those names versus the SPX so the portfolio could very well be skewed.
There's no wrong answer about rebalancing. I'm not a huge rebalancer but it's not that I never do it. Over the years, I've trimmed here and there when holdings get too big relative to the portfolio. Quite a few years ago I trimmed down Nike (NKE) as well as GLD and more recently Novo Nordisk (NVO). This past week I sold half of a name that had a big jump on earnings that I don't think was justified. It's been a while but a few times I had names for clients that were taken over, I sell those names as soon as the news hits. Yahoo comes to mind which I sold in the pre-market when the news was announced, this was maybe 2006 or 2007 and Kinder Morgan Partners when KMI was going to absorb it back in.
Those last three examples are less about rebalancing and more about how I think about selling. The biggest reason that I don't do a lot of rebalancing is the idea of letting winners run. I haven't phrased it that way here, the way I have talked about is to say when you look back at some stock with massive, massive gains over some 20 year period or whatever and you say to yourself "if only I'd bought and held," well that is what I am trying to capture. I've since learned that the fancy word for this is ergodicity. In this conversation, the Peter Lynch quote about rebalancing being akin to cutting the flowers and watering the weeds might be relevant too.
When clients need money out beyond the normal cash flow needs, I might shave a little off of some biggest gainers but try to mix that up a little. In doing this for taxable accounts, there aren't really too many positions that are down which is a byproduct of holding on for a long time. I try to lessen the tax impact where I can but there's really very little offsetting available.
I put a lot of faith into the process of managing the volatility of the portfolio, not individual positions. Things like client/personal holding BTAL for my money, work for portfolio volatility which makes individual position volatility easier to cope with. Whatever you are using to get tech exposure, if you go narrower than broad based index fund, that is one source that adds volatility and probably basis points of return to your portfolio, that's why you own it. Whatever you are using to get consumer staples exposure, if you go narrower than broad based index fund, that is one source that dampens volatility and probably adds yield, that's why you own it.
Diversifiers like BTAL aren't the ones that are going to be 900% in 15 years or compound at 10% like the S&P 500. It makes sense to me to adjust the exposures to those ocassioanlly than to rebalance in the more common use of the word just for the sake of rebalancing.
The comments were of course worth reading. Always read the comments. There were some comments that agreed with the article's premise about rebalancing but more that disagreed for varying reasons. There was the usual distrust of financial advisors added in. One comment against rebalancing from a guy who comments every article, maybe literally every article, said he put $25,000 into Microsoft a long time ago, never sold and now it's worth one point something million. He was candid though in mentioned that he never sold Worldcom or Enron but obviously Microsoft more than made up for it.
Not rebalancing just for rebalancing's sake or as some skeptical comments said, for advisors who think they need to do justify whatever, is one thing but no process for selling isn't great either. There is a balance to this point.
Names aren't important here. These are two stocks that do mostly the same thing. A third name declared bankruptcy and its stock went private in a take under so to speak. The blue line looks like it could be in serious trouble, maybe some sort of distressed buyer would take a stab down 86% but I don't know the story well enough to know if that makes sense. The pink line supports the idea that the group is going through some rough times and pretty much it can be replaced for daily living by Amazon.
Nike, is a name I've held for clients since about 2006. It's had a nasty drawdown that looks like it bottomed at $70, it's at $83 now. It has had some sharp downturns over the years but this one is the biggest. If I am totally wrong about Nike coming back, the way the last two years have gone, it's sort of self-corrected down in the portfolio. I'm not yet at the point of adding to the position and not sure when or if I will but Elliott Hill coming back makes me confident that the decline is over unless something hideous happens from the top down like the S&P 500 dropping 30-40%. All of that notwithstanding, I could just end up being wrong. If you go narrower than a broad index fund, you will get some decisions correct but will be wrong about others.
There was also my favorite type of comment on the article too.
Just buy SCHD reinvest all dividends and go for a hike for 30 years.
We see these types of comments occasionally and they really stick with me for whatever reason. SCHD is the Schwab US Dividend Equity ETF. I'm not going to bag on SCHD but there are some things to consider any time someone says put it all into such and such and forget it.
The chart compares SCHD to VOO and dividends are not reinvested. I took the comment to mean put it into SCHD and live in retirement off the dividends (and Social Security too). Going back ten years, and assuming the dividends are spent, the SCHD position is smaller by about $7300. SCHD's standard deviation is lower by 49 basis points but it compounded lower by 315 basis points. The dividends paid out over 10 years per Portfoliovisualizer was $4893 versus $2866 from VOO.
So, $4893 of income per $10,000 invested. An investor with $1 million in SCHD would have made $489,300 over ten years. But that's not quite right. Dividends are taxed in ordinary income rates. What bracket might this person be in? 12%, 22%, 24%? Those three cover most people. So $489,300 becomes $430,584, $381,654 or $371,868 for most people. Long term capital gains are taxed at lower rates. If your income is taxed at 12% it is likely that your long term capital gains rate is zero. If your tax bracket is 22% or 24% then chances are your long term capital gains rate would be 15%.
In many instances, it would be more tax efficient to sell shares than to live off of dividends. If you are pulling from an IRA, you are paying ordinary income rates on those withdrawals so if you put it all into SCHD in your IRA, then you would be giving up 315 basis points per year (looking back obviously) but your volatility would not be much lower. I'm not sure put it all into SCHD is a good call.
What about if you're in some sort of game over mode? SCHD did offer a lot of crisis alpha in 2022 but the volatility is pretty high for all the return you'd be giving up. There are better ways to build out a portfolio that points to some variation of "game over."
That's not to say that there isn't a place for the attributes that SCHD might bring to a portfolio. If you can figure out some sort of blend. Is this compelling?
It outperforms market cap weighted with a slightly lower standard deviation and a little more yield. It's incremental but was the worst performer of those three only one time in the 10 full and partial years studied.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
No comments:
Post a Comment