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MONTHLY INSIGHTS – JUNE 2023
Edelman Financial Engines
May 23, 2023


A SECRET BEHIND PORTFOLIO MANAGEMENT: REBALANCING


KEEP YOUR PORTFOLIO’S ASSET ALLOCATIONS IN LINE WITH YOUR GOALS.

Here’s a basic question: Why do you have an investment portfolio?

If you’re like most people, you hope your investment portfolio will provide the
money you need to achieve a goal or a series of goals, such as securing a
comfortable retirement, purchasing a home and/or putting children through
college.

Ideally, your portfolio has a specific asset allocation designed to help achieve
these goals over time – in other words, a certain percentage allocated to stocks
and a certain percentage allocated to bonds. However, you can’t expect a
portfolio to retain its original asset allocation year after year. A portfolio
requires ongoing review and “rebalancing” of these allocations back to their
originally targeted percentages.


PORTFOLIO DRIFT

Putting this another way, your portfolio’s asset allocations are susceptible to
“drifting.”

Due to inevitable market fluctuations, some asset classes and individual
investments may rise in value more than others, and some may fall in value more
than others. And as time goes on, your portfolio will cease to resemble the
asset allocation you have targeted to help reach your goals, aka portfolio
drift. Portfolio drift can potentially hinder your ability to reach your goals.

That’s why portfolio rebalancing is critical.


WHAT IS PORTFOLIO REBALANCING?

What does portfolio rebalancing entail? Simply put, portfolio rebalancing
involves buying and selling securities so that the weighting of each asset class
stays consistent with the original allocation.

For example, let’s say that you initially constructed your portfolio with a
target asset allocation of 60% stocks and 40% bonds. However, over time, let’s
say stocks outperformed the bonds and now your portfolio consists of 75% stocks
and 25% bonds.*

In this scenario, rebalancing would require selling some stock exposure and
using the proceeds to buy more bond exposure. This helps you reset your
portfolio allocation to the original 60-40 distribution.


WHY IS A REBALANCED PORTFOLIO ESSENTIAL?

Regular rebalancing is critical partly because it helps manage portfolio risk.
Let’s explain.

A well-diversified portfolio can include both stocks and bonds. While stocks
have generally outperformed bonds over the long term, they carry the risk of
declining in value. Stock values also historically have been more volatile than
bonds. To hedge against the risk of fluctuating stock values, investors
historically have used bonds, which can be a lower-risk, but also, lower-return
investment option. (It should be noted that bonds are not immune to losses, as
we saw in 2022.)

Using the example above, the value of the 75% stock-25% bond portfolio could
grow faster but also represents a riskier allocation than the original
allocation, and that risk level may run counter to your goals, depending on your
risk tolerance and time frame.

For instance, a riskier investment strategy might be appropriate for a young
adult trying to grow their wealth because they have time to make up for
potential losses. On the other hand, an older adult might consider a lower-risk
strategy to help protect their portfolio’s value as they approach retirement
age.


WHAT IS THE BEST APPROACH TO PORTFOLIO REBALANCING?

Rebalancing can be more complex than it seems. It can require expertise and
time. Let’s review two approaches to see why.


REBALANCING BY TIME

When you rebalance by time, you pick a date on the calendar for rebalancing.
Annual rebalancing is a common tactic. Think of it like a yearly doctor’s
appointment to check up on the health and performance of your assets. Others
choose to do it quarterly. Some employer retirement plans and funds also allow
you to set up automatic rebalancing dates to simplify management.

The downside to this approach is that your portfolio may not need to be
rebalanced on the date you choose. In fact, your allocations could get out of
alignment at any time between the date of your last rebalance and your next –
potentially exposing you to unwanted risk.

Rebalancing by percentage can help eliminate this problem.


REBALANCING USING PERCENTAGE

When you rebalance based upon percentage, you start by setting up what are known
as “drift parameters” for each asset class. These are the targeted allocation
thresholds that you don’t wish to exceed.

For example, you may decide that U.S. value stocks can make up as much as 28% of
your portfolio or as little as 22%. If your allocation drifts past either of
these thresholds, then it’s time to rebalance.

The advantages of this approach are twofold: You rebalance as soon as possible
so that you reduce exposure to excess portfolio risk, and you only rebalance
when needed.

This second point is particularly important if you are rebalancing a portfolio
outside of a tax-sheltered account. Each time you sell an asset, you are
potentially exposed to tax liabilities if there are any realized gains, and both
buying and selling of assets can result in trading costs.

However, rebalancing by percentage also means that you have to watch your
portfolio daily to make sure your asset allocation stays within your drift
parameters.

That’s where professional investment management can help. Rebalancing is
critical and it can be complex.  At Edelman Financial Engines, we constantly
monitor client portfolios and will rebalance them when needed.

If you would like to learn more about how you can help ensure your portfolio is
rebalanced when necessary, contact an Edelman Financial Engines advisor at (855)
224-1379, weekdays from 9 a.m. to 9 p.m. ET. We’re here for you.

© 2023 EDELMAN FINANCIAL ENGINES, LLC. THIS PUBLICATION IS FOR INFORMATIONAL
PURPOSES ONLY AND DOES NOT CONSTITUTE INVESTMENT ADVICE OR AN OFFER TO BUY OR
SELL ANY SECURITY. FUTURE MARKET MOVEMENTS MAY DIFFER SIGNIFICANTLY FROM THE
EXPECTATIONS EXPRESSED HEREIN, AND PAST PERFORMANCE IS NO GUARANTEE OF FUTURE
RESULTS. EDELMAN FINANCIAL ENGINES ASSUMES NO LIABILITY IN CONNECTION WITH THE
USE OF THE INFORMATION AND MAKES NO WARRANTIES AS TO ACCURACY OR COMPLETENESS.
FUTURE RESULTS ARE NOT GUARANTEED BY ANY PARTY. FINANCIAL ENGINES® IS A
TRADEMARK OF EDELMAN FINANCIAL ENGINES, LLC. ADVISORY SERVICES ARE PROVIDED BY
FINANCIAL ENGINES ADVISORS L.L.C. (FEA), A FEDERALLY REGISTERED INVESTMENT
ADVISOR. CALL (800) 601-5957 FOR A COPY OF OUR PRIVACY NOTICE. BLOOMBERG INDEX
SERVICES LIMITED. BLOOMBERG® IS A TRADEMARK AND SERVICE MARK OF BLOOMBERG
FINANCE L.P. AND ITS AFFILIATES (COLLECTIVELY “BLOOMBERG”). BARCLAYS® IS A
TRADEMARK AND SERVICE MARK OF BARCLAYS BANK PLC (COLLECTIVELY WITH ITS
AFFILIATES, “BARCLAYS”), USED UNDER LICENSE. BLOOMBERG OR BLOOMBERG’S LICENSORS,
INCLUDING BARCLAYS, OWN ALL PROPRIETARY RIGHTS IN THE BLOOMBERG BARCLAYS
INDICES. NEITHER BLOOMBERG NOR BARCLAYS APPROVES OR ENDORSES THIS MATERIAL, OR
GUARANTEES THE ACCURACY OR COMPLETENESS OF ANY INFORMATION HEREIN, OR MAKES ANY
WARRANTY, EXPRESS OR IMPLIED, AS TO THE RESULTS TO BE OBTAINED THEREFROM AND, TO
THE MAXIMUM EXTENT ALLOWED BY LAW, NEITHER SHALL HAVE ANY LIABILITY OR
RESPONSIBILITY FOR INJURY OR DAMAGES ARISING IN CONNECTION THEREWITH. ALL OTHER
INTELLECTUAL PROPERTY BELONGS TO THEIR RESPECTIVE OWNERS. INDEX DATA OTHER THAN
BLOOMBERG IS DERIVED FROM INFORMATION PROVIDED BY STANDARD AND POOR’S AND MSCI.
THE S&P 500 INDEX AND THE S&P SMALL CAP 600 INDEX ARE PROPRIETARY TO AND ARE
CALCULATED, DISTRIBUTED AND MARKETED BY S&P  OPCO, LLC (A SUBSIDIARY OF S&P DOW
JONES INDICES LLC), ITS AFFILIATES AND/OR ITS LICENSORS AND HAS BEEN LICENSED
FOR USE. S&P®, S&P 500® AND S&P SMALL CAP 600®, AMONG OTHER FAMOUS MARKS, ARE
REGISTERED TRADEMARKS OF STANDARD & POOR’S FINANCIAL SERVICES LLC, AND DOW
JONES® IS A REGISTERED TRADEMARK OF DOW JONES TRADEMARK HOLDINGS LLC. ©2019 S&P
DOW JONES INDICES LLC, ITS AFFILIATES AND/OR ITS LICENSORS. THE MSCI INFORMATION
MAY ONLY BE USED FOR YOUR INTERNAL USE, MAY NOT BE REPRODUCED OR RE-DISSEMINATED
IN ANY FORM AND MAY NOT BE USED TO CREATE ANY FINANCIAL INSTRUMENTS OR PRODUCTS
OR ANY INDICES. THE MSCI INFORMATION IS PROVIDED ON AN “AS IS” BASIS AND THE
USER OF THIS INFORMATION ASSUMES THE ENTIRE RISK OF ANY USE MADE OF THIS
INFORMATION. MSCI, EACH OF ITS AFFILIATES AND EACH OTHER PERSON INVOLVED IN OR
RELATED TO COMPILING, COMPUTING OR CREATING ANY MSCI INFORMATION (COLLECTIVELY,
THE “MSCI PARTIES”) EXPRESSLY DISCLAIMS ALL WARRANTIES (INCLUDING, WITHOUT
LIMITATION, ANY WARRANTIES OF ORIGINALITY, ACCURACY, COMPLETENESS, TIMELINESS,
NON-INFRINGEMENT, MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE) WITH
RESPECT TO THIS INFORMATION. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT
SHALL ANY MSCI PARTY HAVE ANY LIABILITY FOR ANY DIRECT, INDIRECT, SPECIAL,
INCIDENTAL, PUNITIVE, CONSEQUENTIAL (INCLUDING, WITHOUT LIMITATION, LOST
PROFITS) OR ANY OTHER DAMAGES.

INVESTING STRATEGIES, SUCH AS ASSET ALLOCATION, DIVERSIFICATION, OR REBALANCING
DO NOT ASSURE OR GUARANTEE BETTER PERFORMANCE AND CANNOT ELIMINATE THE RISK OF
INVESTMENT LOSSES. THE ARE NO GUARANTEES THAT A PORTFOLIO EMPLOYING THESE OR ANY
OTHER STRATEGY WILL OUTPERFORM A PORTFOLIO THAT DOES NOT ENGAGE IN SUCH
STRATEGIES. FUNDS AND ETFS ARE SUBJECT TO RISK, INCLUDING LOSS OF PRINCIPAL. ALL
INVESTMENTS HAVE INHERENT RISKS. THERE CAN BE NO ASSURANCE THAT THE INVESTMENT
STRATEGY PROPOSED WILL OBTAIN ITS GOAL. PAST PERFORMANCE DOES NOT GUARANTEE
FUTURE RESULTS.

*THIS IS A HYPOTHETICAL ILLUSTRATION MEANT TO DEMONSTRATE THE CONCEPT OF
PORTFOLIO DRIFT AND IS NOT REPRESENTATIVE OF ANY SPECIFIC INVESTMENT VEHICLE OR
CLIENT SITUATION.

AM#2911957


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