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Portfolio Rebalancing: Keep Risk in Check

Summary

Near the end of the year, after the market has been up 20%+ for the past 2 years: now is a good time to check in on your portfolio balance. Do you still have the correct mix of stocks and bonds to meet your goals?  🤔

It’s important to understand your financial goals and have a portfolio balance that has the best chance to reach them. And if you had that dialed in (you did, right!?) - then it might currently be out-of-whack.  The stock market has gone straight up, while your bonds have been stuck on idle. So you might find that your portfolio has too many stocks, leaving you at risk of a bigger fall.

Check out your entire portfolio, not just your 401(k).  Don’t forget about your brokerage account, your IRA and if you’re married: double those. Add it all together and see where you sit in stocks versus bonds. Does that match your goals, risk tolerance, and risk capacity?

Photo by Nick Morrison on Unsplash

Transcript

[00:00:00] Matt: Welcome to real financial planning, broadcast on WK, Excel, and available wherever you get your podcasts. I'm Matt Robinson. I'm joined as always on this outstanding show by Mike Morton. Mike Morton is a financial planner. He is a podcast host. He has his own podcast, financial planning for entrepreneurs.

Now the full name, a lot of us have full names, right? Like my mother calls me Matthew, but most people call me Matt. So the full name is financial planning for entrepreneurs and tech professionals, but like in the movie, the social network, instead of calling it the Facebook just Facebook it's cleaner.

Mike has gone with financial planning for entrepreneurs, the tech professionals get the old Heath. Oh, huh.  

[00:00:43] Mike: That's right. Yeah, I know. No, don't say it that way. Matt. That's  

[00:00:46] Matt: Oh, no. Oh, We love tech professionals They've done nothing but great things for our society. Really.  

[00:00:52] Mike: easy there,

[00:00:53] Matt: Okay. All right. All right? No. All of Mike's clients. I love you.  

[00:00:55] Mike: Right? No. All kidding aside. It just didn't fit on the cover art for the podcast. So it got dropped

[00:01:02] Matt: That's usually how it goes, right.

It is, we've been doing a run of shows and look, when people listen to these things on podcasts, they're pretty evergreen. Like all the topics we talk about, they could be totally relevant anytime of the year. But, we do record these throughout the year and we've just been in a run of shows recently of issues that are, I think, particular.

On your mind, cause it's the end of the year. And we're thinking about what issues come up the end of the year. So we did tax planning, we did eight tips and tricks. We had a great two-parter recently that's in that financial planning for entrepreneurs, podcast room, like eight great tips to save on your taxes.

Pretty easy things you can do. So I urge people to check that out and you've got another one today that I think goes under that theme of, Hey, here's some things to maybe think about towards the end of the year.  

[00:01:49] Mike: Yeah, it's exactly right. This one is portfolio rebalancing. And so here at the end of the year, and especially since the market again has been on a tear in 2021, we've had a little volatility here the last week. We're recording this what first a week of December. This has gone up and down a little bit, but by and large, completely up for the year.

So now is a great time to make sure that you have the right balance left and right up and down in your portfolio. And so that's why I'd like to speak about today, but going back to the tax tips, I will say this. I took our idea of eight tax tips and turned it into a whole advent calendar of tax tips, a whole 25 tax tips for end of year or anytime of year on my LinkedIn profile.

So if you want even more text tips,

[00:02:36] Matt: You know, our Our advent calendar, I'm in a a dual faith household. Our advent calendar is a, I don't know, it's a cheapo version instead of giving you biblical, like the run-up to the birth of Jesus. As a Jewish man, this is what I thought that was all about. It's giving you towards the night before Christmas.

So it's kind of a knockoff version. I don't know. Meanwhile, we've got the advent calendar going. We've got the advent candles going. We've got the menorah going. What we really need to do is diversify our household more and get the quantity. Thing. So anyway, the point is you've got eight. So if Hanukkah is on your mind, check out the eight version.

If Christmas is on your mind, you've got a full advent calendar and we will do a Kwanzaa adaptation at some point. All Right.

So portfolio rebalancing. What does that mean? I think I know what a portfolio is, but what are you talking about when you're talking about balancing and.  

[00:03:26] Mike: Yeah. So in your portfolio, and what I'm talking about is money that you're setting aside to spend in the. So when I say portfolio investment portfolio, you might think of it as a retirement funds. This is money that is set aside for you to spend in the future.

And what we want to make sure is that you have the right mix of assets within that portfolio to reach your. Okay. So typically we always start with stocks and bonds. Quick refresher stocks are an investment in companies. You've purchased a little tiny sliver of that company. You hope they continue to do well, make great products, sell services, make profits, and you own a small piece of that company.

So hopefully it goes up in value over time. Bonds are an IO. And so what you've done there is you've lent money to a company or to the government, and they're going to pay you back over time. They often have an interest rate associated with them. So that's an IOU where you're lending money. So one is buying a sliver of that company and the other is an IOU.

 And bonds. And that's where we start the discussion around a portfolio balance because each of those, what we call asset classes, each of those investments has a different volatility, how much it might go up and down in a single year and a different historic rate of return.

[00:04:47] Matt: I just want to point something out that kind of caught my ear there. And I think longtime listeners may have noticed it too or maybe not. It was interesting when you were talking about your portfolio, your definition is based around goals, and this is something you're really big on in your financial advisor.

Most people talk about risk. I There's a whole show we did together about risk. Look, the word risk is going to come into this. I'm sure we're about to talk about risk. I'm guessing, but I like the modification that you offer to people here is around goals that, that we have to think about the fact that there's going to be the other word you just used.

There's going to be volatility. Any asset you have could go. I could go down. The value is going to fluctuate and you're taking on some risk in that. But the risk is not that it will go up and down because that is going to happen. That is the nature of these things. It's you're going to ride a rollercoaster.

It's going to go up and down. That's what it's all about. It's the risk that you're undertaking is you will not reach your goals. And so I just think that's an important context here that what we're not talking about is volatility. As a bad thing, per se, what we're talking about is managing across all the assets you have so that you have the best possible chance of achieving your goals.  

[00:06:05] Mike: That's right. And usually when you say the word goals, often their financial goals, so they have some money tied to them. So the easiest example is retirement. At some point I'm going to work, I'm going to work 23 more years and then I'm going to stop work and I need money . For my expenses when I stopped work.

So there's one, potential financial goal that we need to work towards and put dollars aside so that we can reach that goal. Now, when you're talking about the portfolio again, rebalancing, so we're talking high-level stuff. And bonds. And you mentioned the word risk. So that's going to come right in here.

And there's two parts to the risk of your portfolio. There's risk tolerance and there's risk capacity. So risk tolerance, everybody has a different tolerance for risk. Some people like to score. Some people like to, go on high wires or do other risky ventures, other people, and not so much like to play it safe.

So it doesn't necessarily translate one-to-one into investments. People that want to do risk taking with other aspects of their life don't necessarily want the risk to. In their financial life, but of course there are, risk-taking how much risk you're willing to take.

Hey, if the stock market goes down, if you're a portfolio, your dollars, that a hundred thousand dollars you have in your 401k goes down to $70,000. How bad will you feel and what might you do about it? That's a risk tolerance. Risk capacity is think about it this way. If you are retired, And you have just enough to live on.

You really don't want to take a risk with that money. You have just enough to live on. You have to be very prudent and conservative around that money. Whereas if you're 25 and you got a great career ahead of you, you have lots of risks, capacity, that thousand dollars you're putting into your 401k, it could go up and down.

You hope it's going to grow over time, but you have huge risks capacity because of where you are in.

[00:07:58] Matt: I just want to point out that you're a guy who exactly embodies what you were just talking about. I know for a fact that you've gone skydiving in your life. I also know for a fact that you're not like a big risk investor kind of guy, which is why you have so many clients who don't want to like, go play the stock market, like a casino with their money.

I guess those two things don't always necessarily line up, a skydiving risk-taker and their investments. All right. That's actually, that's a distinction I've heard before. Risk tolerance, risk capacity. That's a good explanation. So how does that then play into portfolio?  

[00:08:29] Mike: So I play some portfolios. One is just, you want to understand both aspects of that? Because on the risk tolerance side, I don't want you to be in a hundred percent stocks. And then they go down by 30% of that, that a hundred thousand dollar balance goes down to 70,000 and you're sweating bullets the whole time and stressing and you can't sleep and I can't do this anymore. I'm just going to sell. That is what I do not want you to do. And that's a risk tolerance. So you have to have some understanding of in your portfolio. Again, stocks versus bonds. We're going to talk more about a minute. That portfolio balance goes down from, geez, I'm gonna retire in five or six years.

I have a million dollars saved. Now my million dollars is worth 800,000. What are you going to do? You have to know that ahead of time. We just had this a year and a half ago, March. You remember those three weeks, you don't remember at this point, but it went down 30%. So your million dollar portfolio.

Might have gone down if you were heavily in stocks down to $700,000. And how did that feel? So I don't want you to sell out at the bottom if that happens. So therefore that would not be the right allocation, risk tolerance allocation for you now, risk capacity. You've got to balance that out. If you're 35 and you have that million dollar portrayal.

Good for you. And if it goes down, and you say, oh, no problem. I'm still adding to it. I'm still on my job. I'm adding two more 401k. I'm buying in why stocks are on sale. I know it's going to come back and I'm not touching this money for 20 years  

[00:09:53] Matt: playing the long game at  

[00:09:55] Mike: you're playing the long game. So even though your risk tolerance, we might be sweating a little bit.

You want to play it off with your risk capacity to him and understand? No, it's okay. Minnows for the.

[00:10:03] Matt: Got it. So it's really about, you're looking at those two aspects and you're matching that up with all right. Across my whole portfolio. What does my risk look like? What does my volatility look like? And am I good with that? It does it match up with my risk capacity and my risk tolerance?

[00:10:25] Mike: And the other thing to think about, and these can play off in different ways. So I've had clients who are about to retire that have over saved and it's tremendous, it's great. They have quite a lot of money and they don't really spend a lot, they've been, they're big savers, they've been super saving.

And so they actually still have a lot of risk capacity. Even though they're retiring, they have a large portfolio, which gives them more flexibility to take on more risk because they have over saved. So there's an instance again, where you have more risk capacity, even though your tolerance might be like, geez, I do not want to take any of this and be risky.

That's fine. You don't have to necessarily, but just understanding both sides of that equation.

[00:11:02] Matt: I just want to point out since I put you on blast a second ago is like the skydiving risk averse person in your portfolio. I'm, I've fall into that category. I'm not saying I'm an over saver. It's not like I'm rolling in dough here or anything, but like when I get an extra. I'm literally the kid who's great.

I'm going to go to the bank and I'm going to put this away. And someday it will go toward my college fund. I really, I seriously, I talk about this with my wife all the time. It's if we ever have a little extra money, it's Should we try to live a little no, we never go anywhere.

We'd never do anything. We're dull. I'm.  

[00:11:33] Mike: we try to live a little, I like it, man. Maybe you should up your game a little bit in that area.

[00:11:37] Matt: We're definitely going to convene a committee to talk about the possibility of exploring whether we should live a little. All right. So now we've gotten to the point of you. You're going to look at your portfolio. What are you looking for?  

[00:11:47] Mike: Yeah. Yeah. All right. So now we've got, first of all, I do want you to just dial in kind of that portfolio balance. So risk, capacity, risk tolerance. I want you to understand the stocks versus bonds, the volatility stocks historically earn a lot more, but they go up and down a lot more.

Okay. So now this idea that if I'm investing a dollar for 10 years from now, I can probably put that in company. By a little sliver of the companies invest that in stocks, because over 10 year periods, they generally do pretty well. If I need that money next year, heavily leaning towards checking savings, account money market, short term bonds.

I need that money next year. Okay. So we've got a framework and I want you to understand that your portfolio is a mix of those. So if you're young again, you might have, 70, 80, 90% invested in stocks. Okay. And the rest. If you're in retirement and you're that conservative, I have just enough to live on and I'll be fine.

Maybe your 50% in stocks and 50% in bonds, right? That's always the first split that we look at. I'm probably going to keep it there for this discussion. We've talked about different asset classes in large companies and small companies and U S and international, of course, we want to do all that diversification.

Okay. It's one of the only free lunches in the stock. Is diversification, but for now, for this discussion, let's talk stocks and bonds. So you've dialed in where you like to be, whereas comfortable from you, risk tolerance and risk capacity, and you decided, Hey, I'm in the middle, late part of my career. I'm going to be 70% stocks, 30% bonds.

And that's a good allocation for me.

[00:13:22] Matt: Got it. All right. And I just, that last thing you said there, let me just read it. That was literally the question I was about to ask, because, nowadays it is more complicated than that, right? Just for me.

I'm a former federal employee and the federal employee 401k is basically called the thrift savings plan.

Why did I have to make it complicated? Why don't they just say it's your 401k, whatever. Anyway and they try to make it easy by saying, all right, you can put yourself into this mix where this makes and the mic. Of stocks involves international small cap international, high growth domestic.

Anyway, you've got, it's more exotic under the, under that surface, but what you're saying is look, keep it simple. There is an average of stock volatility and risk. There's an average of bonds. That's good enough for balancing your portfolio.  

[00:14:11] Mike: Yeah, exactly. There's nuances, of course, like with anything, but for this conversation, we're going to keep it at that really high level. Now, maybe Matt, we should have a conversation about asset classes. I don't know if we have a podcast about all the different asset  

[00:14:26] Matt: Let's do it, but make a note. If you don't hear it from us within the next four weeks you get an hour free counseling from Mike Morton. So just go to  

[00:14:33] Mike: With Matt Robinson about how to run podcasts.

[00:14:36] Matt: you don't want an hour free counseling from me. That's valueless got to give away something of value.  

[00:14:43] Mike: So you're, you've dialed in, where you like to be. All right. So from that portfolio perspective, and another question is how do you even know where you are? So I think 70, 30 sounds pretty good for reaching my goals, setting me on the right path. And for , my risk tolerance risk capacity, how do I even know them that.

A lot of the, there are tools, a lot of the websites where you have your 401k, we'll give you, that breakdown, that pie chart of, stocks and bonds. And then, like you said, Matt, us and international have little color codes for those different things.

[00:15:12] Matt: Honestly nowadays, that's the first thing I see when I log in I've got my five 20 nines, at one company, big companies. I'm not going to say where, because there are hackers out there. I don't know. But one company I've got.

[00:15:22] Mike: I'm coming after you, Matt. You're the big  

[00:15:24] Matt: and all my assets.

It's because I'm either an entrepreneur or a tech professional, yeah, but that's the very first thing that they show on the screen these days they'll show your pie chart. They'll show like the average pie chart for someone like you. And that's I find that super helpful,  

[00:15:37] Mike: Yup. Now be aware that they're doing that just with whatever's held at that instance. So that's a big problem because you've got your 401k that's with your current job and it's somewhere, and then you've got your brokerage account and then you've got your checking account. And then by the way, you might be married.

So double all those accounts and you really want to know across everything. So that's important.

[00:16:00] Matt: point. I didn't even think about that again with my, all my accounts, but it's true. There are a different things. And nowadays, so many people. They might th there they leave jobs. And so you've got a 401k from your old job. They make it a pain in the butt to try to roll over from a 401k at your previous employer to an IRA.

So many me bill kinda let that slide. That's an episode we should talk about to my gosh, talking about a practical problem for people.  

[00:16:23] Mike: it turns out those companies like to have your money met.

[00:16:26] Matt: Oh, yeah. It's kinda trying to quit the gym. It's I want to go quit the gym. Oh yeah. Just fill out this form and then bring it to the top of that mountain over there. It'll be fine. It's real easy. So let me ask you this. We're doing this because we're reaching the end of the year.

How often should I be doing this? And I think the whole point is you shouldn't be fussing with your accounts that often.  

[00:16:44] Mike: That's right. That's right now here, we're going to finally get into the meat of this episode. That's okay. We've barely started. We're only about 20 minutes in so far, the meat of this episode. That you want to make sure you maintain that allocation that you've decided is right for you to meet your goals.

If you've decided that 70, 30 is the right mix for you, then you need to maintain that 70 30. Okay. So let's just say, Matt, that you haven't checked in. In the last couple years, you just working life. I don't know. Maybe it has been busy the last couple of years for, one reason or another.

And you haven't really checked in. The market's gone up about 20%, both years, so far. Okay. So now that's 70 30 mix. You had 70% stocks. That's 70% side has gone up by 20% last year and 20% this year. So now maybe you're over 80% because the bond side has not been. All right. It is not risen nearly as much.

Okay. So you got growth in that, that 70% side, not so much growth in the 30% side. So now when you look at the big pie chart, it's staring you in the face and says, yeah, cool. You're at 80% stocks and 20%. And that is not what you decided you wanted to be. You decide, Hey, I want to be 70, 30. So that's when you need to make a shift is when the market's been going for a while, you check in and you say, geez, if you're off by a couple of percent, no big deal.

But as soon as you get off by, 70 to 75 or to 80 that's when you need to dial it back in.

[00:18:15] Matt: What do you do at that point? It's this feels like a pamphlet in a doctor's office, saw your portfolio is out of balance. So what do you do? Do you, is there a simple rule of thumb for what you buy and sell at that point?  

[00:18:26] Mike: Yeah, not, unfortunately I don't have a simple rule of thumb for  

[00:18:29] Matt: Call Mike Morton.  

[00:18:30] Mike: I can, I'm going to tell you what to do for sure, but it's not just oh, here, know here's the prescription, the, what you need to do. It's simple, right? If you're struggling. Have gone up, you're invested in a couple of different stock funds or mutual funds, and they've done really well for the last couple of years.

So congratulations. You've stuck with it and they've done really well. And it's great. Then you need to sell some of those. So you have to look at your, if you have a million dollar portfolio and now it's 800,000 in a couple of stock mutual funds and 200,000. In some cash and bonds, you need to sell 100,000 of your stocks and buy cash and bonds and money market funds.

Okay. Fixed income.

[00:19:14] Matt: And just a quick note on that. I'm assuming that before you rush out and call, sell, sell, sell, it's like the commodity traders and trading places. It's just get in there, sell that frozen, concentrated orange juice. probably want to consult with either financial advisor or listen to some of our episodes, including our recent ones about tax tips, because I'm sure that, there's going to be a capital gains tax hit in that equation.

So there are probably ways you could think about doing that, that can minimize the tax  

[00:19:45] Mike: Yep. So what you want to do is you want to do this in your tax deferred or tax-free accounts, 401ks your IRAs. If you have the opportunity, that's what we rebalanced. Now, the other reason we're bringing up in this episode, and while we're doing this now is because of. The market's gone up 20% a year for the last two years.

Your portfolio is by definition out of balance. If you have not been monitoring it. And so now's a good time for that reason alone. The second reason I bring it up, we've said this a number of times. I feel it now's a good time for it to continue to be defensive. You will keep hearing me say this until such time that the market comes down 2030.

Okay, because it's good to hear the same message over and over, right? The stock market is fairly valued to over-valued. That's fine. That happens all the time. Probably 50% of the time it's fairly valued or overvalued. So just be defensive. If you're normally 70, 30 stick with 70 30, if you normally 80 20 stick with 80 20, don't get too aggressive.

Don't let your portfolio float out of balance and get you more aggressive than you want.

[00:20:49] Matt: And if. A long time listener who has heated the Mike Morton advice. Hey, you know what I like target date funds. They're great. They make it easy. So they're automatically adjusting for you. So I'm going to try and go back into my memory on this. It seems like your homework should be almost done with target date funds because they do that automatic rebalancing of your risk profile against your target retirement or your target.

This is when you're sending your kids to college with a little bit of an exception. I think it involves defensiveness. Is that.  

[00:21:20] Mike: Yeah, the target date funds. They are fantastic. And so all of this is being done for you. So if you're, if you could have started with that, Hey, if you're in a target date fund skip to the next episode.

[00:21:32] Matt: But it's not, but there is a little coffee out there, right? Because you could adopt more defensive posture by maybe selecting a different fund and like gaming it a little.  

[00:21:42] Mike: That's right. The thing about target date funds, I'm a huge fan of target date funds. I love them. But they are the average, they're made for average consumers. And so you need to make sure it makes sense for you. So I often have clients pick a different fund number, 20, 40, 20, 45, 20 50, then their actual return.

Okay, so we might shift it by five or 10 years. Oh, I know you're retiring probably in 2040, but let's do the 20, 45 fund or the 2030 fund, because it's just an easy way of getting the right mix for what you need to reach your goals. Now, that being said, just pick the one, start with the one that's near retirement day.

That's like I said, great place to get started, but just understand as maybe for the average consumer may not apply to your specific situation.

[00:22:27] Matt: And so an easy shorthand is just choose sooner because it's going to be more defensive. If you want to reallocate just a little bit just choose a few years sooner. All right. Look, we're about to wrap up lightning round question. Would you, at this point in your life, go skydiving again.  

[00:22:43] Mike: The best part of that skydiving was the scene after when all five of us were on the ground, on our phones to our significant others. Yes. We're safe. We're back on the ground.

[00:22:53] Matt: That's okay. I've hit the ground.

and That's good news. I don't think that's a good sign for the activity you're doing. All right. We're going to have to sign off here. Mike Morton financial advice, financial planning for entrepreneurs. Thanks so much.

[00:23:05] Mike: Thanks for joining us on financial planning for entrepreneurs. If you like, what you heard, please subscribe to and rate the podcast on Apple iTunes, Google play Spotify, or wherever you get your podcasts. You can connect with me on linkedin or mortonfinancialadvice.com. I'd love to get your feedback. If you have a comment or question, please email me at financialplanningpod@gmail.com. Until next time thanks for tuning in