October was National Financial Planning Month and, this year, you decided it was high time you had a reason to celebrate. Now you’re leaving your financial advisor’s office, freshly minted plan in hand and a smile on your face. Before you stuff that document into your file cabinet and bust out the champagne, you should know what NOT to do if you want your financial peace of mind to last.
“A great financial plan is the single most important determinant of your financial success,” according to Greg Phelps, CFP®, CLU®, AIF®, AAMS®, of Redrock Wealth Management, Las Vegas, NV. But there’s another crucial factor: you – specifically, your ability to stick with the plan despite the endless temptations to sabotage it.
That doesn’t mean “set it and forget it” forever. It means periodically monitoring to ensure it still contains solid investments in the right mix as markets and life circumstances evolve. This is known as rebalancing, and the way you approach it really matters.
“Rebalancing is important for several reasons, not the least of which is to maintain consistent exposure to your expected long-term risk and volatility levels,” says Phelps.
Not only that, returns can really suffer when investors move money into or out of the wrong investments at the wrong time for the wrong reasons. With that in mind, here are three ways NOT to rebalance.
- Every 10 Days
One way investors derail their portfolios is by paying too much attention to them. Often, this is the result of a severe case of financial FOMO (Fear of Missing Out). The always-on financial media emits a constant stream of “news” designed to grab your attention. Sometimes, it’s touting the new new investment, which promises a previously unheard-of return… with virtually no risk.
Other times, this behavior is driven by FUD – Fear, Uncertainty, and Doubt – about the future. Investors are constantly subjected to dire warnings of the world’s imminent demise, and the corresponding shrinkage of related markets. Anyone hearing these doom-and-gloom messages 24/7 could be forgiven for wanting to stash their nest egg under the mattress.
- Every 10 Years
Conversely, some investors pay too little attention to their portfolios. They stick their heads in the sand for the same reasons people put off going to the doctor: busy lives, cost, denial. More probably, it’s fear of finding out something they don’t want to know. So they let their portfolios steer themselves, sometimes for decades.
“It’s easy to see how investors can get overwhelmed. There are so many choices, not all good or easy. It can lead to inaction,” observes Karen A. Miller, CFP®, Gasber Financial Advisors, Inc., of Folsom, CA.
Whatever the motivation, investors afflicted with financial denial put themselves at risk just like people who avoid going to the doctor. That’s because more aggressive investments grow faster over time. So a portfolio left to its own devices will inherently veer in the direction of more volatility. Ironically, inaction based on fear brings about the very thing the investor is seeking to avoid: greater uncertainty.
- Every 10% Drop In The Dow
Here’s another way investors inadvertently work at cross purposes to their goal: by paying attention to their portfolios only when markets plunge. Let’s call it financial F.E.A.R (False Evidence Appearing Real). Financial FEAR certainly seems an understandable reaction for any investor who lived through the market mayhem that occurred post-9/11 or later that same decade, i.e. most of us.
Understandable or not, this FEAR – and the panic selling that typically accompanies it – virtually guarantees investors sell low and buy high, a recipe for anemic returns. Even those who get lucky and time their exit well, still have to get back into the markets at precisely the right time to avoid missing the eventual upswing. With US markets currently experiencing their second longest bull market ever, conditions are ripe for those afflicted with financial PTSD to get burned once again.
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The Fear Is Real
These 3 ways not to rebalance your portfolio all stem from letting fear drive your investment decisions.
“It’s never the numbers that trip us up,” says Linda Matthew, Accredited Financial Counselor (AFC®) and owner of MoneyMindful Personal Finance Coaching of Davis, CA. “Money can show us who we are and that is not always comfortable.”
Nor is it conducive to a good night’s sleep. Indeed, “financial insomnia” is running rampant, with nearly two-thirds of Americans reporting they are losing sleep over money worries.
Now, behavioral finance, a relatively new field of study, has been amassing evidence of a perfectly good explanation for all this: human nature. Unfortunately, many of the tendencies that have served our species well over time are not our friends when it comes to managing money.
While behavioral finance studies make for fascinating reading, what’s most important is to understand the sheer power of these effects to drive our actions. According to Phelps, scientists have found that the concept of more money (i.e. greed) affects your brain like cocaine!
“Our relationship with money is not rational. It’s almost like a marriage. It can be stormy. It can be charming,” says Matthew. So what do you do to experience more “charming” and less “stormy”?
The Flip Side of Fear
Getting fear to work for you instead of against you is the key to portfolio peace of mind.
“People will try to avoid fear. But if you turn away from fear, you turn away from opportunity,” observes Matthew. “Working with money stress and emotions – bringing these feelings to consciousness – can free people to take positive action.”
“You’ve got to get emotions out of the picture,” agrees Miller. “Understanding the back-story can shed light on emotional blocks.”
And let’s not forget that FEAR is also an acronym for Forgetting Everything’s All Right. In this context, “all right” doesn’t mean great or perfect, just “all right” by historical standards. That’s a history that has included boom times and busts, world wars, 9/11, and other unspeakable tragedies.
Through it all, markets have always behaved – over the long term – in surprisingly predictable ways. Investors who have ignored that, thinking “this time will be different,” have done so at their peril. Even when everything isn’t all right, the portfolio is likely to suffer more as a result of fear-based choices.
Prescription: Rational Rebalancing
Experts agree that the way to keep emotions from sabotaging your financial goals is to take a systematic approach.
“Great investors are almost robotic. They focus on science and evidence. They ignore noise and media… they simply plod through with blinders on to reach their desired destination safely,” says Phelps.
Miller likes the “time plus threshold” approach. She comes up with a target asset allocation for each client, as well as a limit – say, 5% – on how much the portfolio is allowed to stray from that mix. She then rebalances at least once a year, more often if market volatility pushes the portfolio over these predefined limits.
Other financial advisors rebalance more or less often, per a variety of parameters, as described in this GuideVine article. Exactly which systematic approach to use is the subject of some debate. While there’s no one right answer, as Phelps puts it, “consistency is the key because it removes, or mitigates, emotional decisions.”
Prognosis: Many Happy Returns
So when it comes to managing your investments, paying attention with intention pays. So the next time you’re tempted to take a flyer on a hot stock tip, act the ostrich, or cash out on a market swoon, try channeling your inner robot instead. Then keep that up over time, and you’ll have reason to break out the bubbly for years to come.
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