What comes to your mind when someone mentions the 3Rs?
Is it “Reading & ritin’ & rithmetic” as sung to the tune of School Days? (The nostalgic Cobb & Edwards song that captures the reminiscing of a mature couple and their “dear ol’ golden rule days,” when they “were a couple of kids”).
Perhaps it is Reduce, Reuse and Recycle and ways to save the planet since the 50th anniversary of Earth Day was just celebrated?
For all of us at Sequoia, we immediately think Review, Reallocate and Rebalance as we help our clients through this volatile market environment. These are the foundational concepts of successful portfolio management and the basis on which a thoughtful investment strategy is developed. As the expectation for continued market volatility remains, the 3Rs can help remove fear and emotion in times of uncertainty. Let’s take a closer look at each:
Prior to building or making changes a portfolio the first step is Review. A planner/client conversation is necessary to evaluate where you are in light of your personal goals. Regardless of your stage in life, whether you are retired and living off of your portfolio, working to put your children through college, or just starting to build your nest egg for the future, taking time to address these questions are an important first step in portfolio management:
- Take inventory of your financial situation, where you are in relation to your overall goals?
- What is it that you want to accomplish, what are your investing for?
- Has your goal or time horizon changed?
- What have you done so far to move toward achieving those goals?
- Review your current asset allocation
- How are your assets currently distributed between cash, bonds & stock?
- Are you comfortable with the variability present in your portfolio? Does it make you nervous?
- Can you afford to be more opportunistic, or should you be more conservative?
- Review your current cash flow
- Do you have 3-6 months cash on hand as an emergency fund?
- Will you need to draw from the portfolio in the near term?
- Do you expect any changes to your situation that could impact your income?
After reviewing your overall situation, evaluate your asset allocation, the specific components of your portfolio. How is your portfolio distributed among cash, bonds, and stock? Depending on one’s situation and how the above questions are answered, the need for cash, protection, or long-term return will provide the outline for the appropriate asset mix. It is the allocation that determines the risk and potential reward in your portfolio.
In a well-constructed portfolio, the three main asset classes are further diversified to develop a desired allocation. Equities can be broken down between domestic and international, large and small size companies, and high growth or dividend payers. Fixed income positions are distributed largely with an eye on short verses longer term maturity and among varying credit qualities. Proper allocation allows for the possibility that there could always be something down in your portfolio; this is a feature of diversification, not a flaw.
Redirecting one investment in favor of another is a reallocation. There are number of reasons why a portfolio reallocation may be necessary.
- Market conditions or economic outlook may place one asset class in a more favorable light over another
- Investment performance (or under performance) may require a position to be reduced or removed
- A change in risk tolerance or time horizon
Our Asset Management Department and Investment Committee work to develop tactical and investment specific recommendations to our global strategies, while our client service teams work directly to assist in providing guidance related to our clients’ specific risk tolerance and long term goals.
Lastly, when managing a portfolio from time to time, through positive or negative market movements, portfolio allocations will stray from their intended weights. Rebalancing is the process of realigning your asset mix back to the targeted allocation. If you have set out to build a portfolio with a 70% equity and 30% fixed income allocation, market movements will cause those weights to be out of balance. Rebalancing a portfolio gives investors the opportunity to sell high and buy low, while repositioning back to the original weights. This can be done at set time intervals, annually for example or as the portfolio shift demands. A good rule of thumb is making an adjustment when the portfolio is 5% from the original targets.
Rebalacing is also an appropriate strategy if your time horizon or risk tolerance has changed. Moving a portfolio along the risk spectrum either more aggressively or conservatively to be aligned with a desired allocation will help your portfolio keep pace with your current needs. This allows one to make appropriate adjustments while remaining invested, while curtailing timing risk and emotional elements of moving into or out of the market.
Review your situation with your Sequoia advisory team to determine if a portfolio reallocation and/or rebalance is appropriate for your circumstances. Everyone’s situation is different but using the 3Rs can help to remove the emotion associated with uncertainty and ensure your portfolio is appropriately positioned toward the achievement of your goals.
For more information on this topic, contact Jill Branthoover.