Don't Worry So Much About Portfolio Weights And Rebalancing. Let It Ride.

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Includes: ABT, CL, CVS, JNJ, LOW, MDT, MMM, MSFT, NKE, PEP, QCOM, TXN, UTX, VIG, WBA, WMT
by: Dale Roberts
Summary

Many investors will spend a considerable amount of time and energy attempting to keep their portfolio in balance.

Do we need to keep our portfolios in their original composition? That can create costs and taxes for taxable accounts.

Perhaps we can let it ride and let our portfolio drift. Our biggest winners can then take care of the biggest losers.

Portfolio rebalancing can take up considerable time and energy, and it can create a tax burden for those who have taxable investments. Investors face the same questions on when to rebalance whether they have portfolios of individual stocks or ETFs. It's my opinion that we might think about rebalancing too much, and that it often does not require our attention. We might let our portfolios run and drift.

I recently covered Is it time to rebalance your portfolio? Through that writing and reflection I started to drift even more to the camp of passive behaviour with respect to our individual stock holdings and our ETF holdings. That is there might be little need to rebalance our stocks to the original allocations. There may be little need to worry about our 'continental drift' when our geographic mix begins to move away from original settings.

And certainly, my behaviour has been very passive from the date of new portfolio construction that was adopted several years ago. I embraced US Dividend Growth ETFs and Stocks, Canadian Dividend Growth ETFs and Stocks and a Canadian bond component. I went to a very conservative stance (admittedly too conservative) but then continually ramped up the risk and returns potential by investing new monies and portfolio income exclusively in the stocks and equity ETFs. We can call that an equity glide path, and that de-risking and then re-risking is a strategy that is practiced by some retirees and retirement financial planners. I perhaps simply started a little too early.

I have not attempted to keep the US to Canadian allocation to any zone or threshold. The stocks and the market decide that. I am not in any outrageous 'out of balance situation.' On the stock front my wife's accounts are in the range of 60% US to 40% Canadian. For my accounts I am more overweight Canadian stocks thanks to my appreciation for the generous and increasing dividends of my Canadian Wide Moat 7. Given my new life work stage (semi-retirement) I am happy to take the market out of the picture for any needed retirement funding that comes by way of that portfolio - and those dividends.

Please have a read of Taking The Market Out Of The Equation With My Wonderful Dividend Growth Rate. That's, said in dollar terms, I still have a generous enough US component that will help with needed diversification beyond Canada's sector concentration (financials), and will also provide US dollar assets needed for our retirement travels to the US.

From the first article link (above)

As Dan Bortolotti pointed out in his post on the fine art of rebalancing from 1980 to 2019 the returns of a US/Canada/International portfolio are identical for a rebalanced portfolio and a portfolio that was not rebalanced at all.

Perhaps we sweat the asset shifts too much? I am happy to let our portfolios bend as the markets dictate. That said, I am a fan of the rebalancing opportunity that can take place between the bonds and stocks in a major market correction. A Balanced Growth model has kept pace with all stock models thanks to those market corrections and the ability to move funds from the bond component (increasing in value) to the stock component (decreasing in value). Overall, the portfolio model will offer a lesser drawdown and there is the ability to buy those stocks as they go on sale. The major market corrections become the great equalizer. On that, please have a read of The Balanced Growth Portfolio. The Investor's Sweet Spot.

And of course for an investor that holds a bond component to manage the price risk, they might keep that bond allocation in check to match that risk tolerance level. Of course, your risk tolerance level can change over time. You will adjust the stock and bond components accordingly.

What about our individual stock drift?

I learned quite quickly that a portfolio of individual stocks can move out of its original balance in an investment heartbeat. In early 2015 I sold our Dividend Appreciation fund (VIG) and skimmed (purchased) 15 of the largest cap constituents. Here's the list of companies held 3M (NYSE:MMM), Pepsi (NASDAQ:PEP), CVS Health Corporation (NYSE:CVS), Wal-Mart (NYSE:WMT), Johnson & Johnson (NYSE:JNJ), Qualcomm (NASDAQ:QCOM), United Technologies (NYSE:UTX), Lowe's (NYSE:LOW), Walgreens Boots Alliance (NASDAQ:WBA), Medtronic (NYSE:MDT), Nike (NYSE:NKE), Abbott Labs (NYSE:ABT), Colgate-Palmolive (NYSE:CL), Texas Instruments (NASDAQ:TXN) and Microsoft (NASDAQ:MSFT).

While some of the holdings have been removed from the Dividend Appreciation fund I have continued to hold and add a few shares here and there upon occasion, usually purchasing the companies that are out of favour. And I have continued to let the winners run. The portfolio is now certainly bent out of shape.

From portfoliovisualizer.com here's a (hypothetical) look at the returns history, with an equal weight start for these 15 companies from January of 2015 to end of May 2019.

We can see the wide variance in returns and performance and risk characteristics. The allocation drift is considerable. If one starts in equal weight fashion and invests the dividends back into each company, eg. Microsoft dividends are reinvested back into Microsoft, we end up in a scenario where some of the winners are nearly 3x times the position of the biggest losers.

While we'd start with 6.66% in each company in 2015, by end of May 2019 Microsoft will represent 11.9% of the portfolio value, while CVS is just 3.6%.

Here's the full list for portfolio allocation, figures rounded.

  • CVS 3.6%
  • PEP 6.5%
  • MMM 6.3%
  • UTX 5.0%
  • TXN 9.7%
  • CL 4.6%
  • WMT 5.9%
  • NKE 7.9%
  • LOW 7.0%
  • QCOM 4.3%
  • MSFT 11.9%
  • ABT 8.7%
  • MDT 6.7%
  • JNJ 6.8%
  • WBA 4.8%

Does it matter? Would rebalancing create greater returns? It may not surprise you that letting the winners run created greater returns at 8.64% (let 'em run) to 8.24% (rebalance annual). We have been mostly in a bull market run for the period and the corrections have been minor.

If we go back to the start of 2010 and run these same companies we find that the returns are nearly identical and the risk level (standard deviation) is also nearly identical. And perhaps surprisingly, the allocation drift is less. Keep in mind that there is survivorship bias at work here. We are selecting companies that were 'good enough' to make it into the Dividend Achievers Index, they were able to pass the dividend health screens and were increasing their dividends for the near 10-year period.

All said, this suggests that we may not need to worry as much about allocation drift with respect to returns and risk. An investor such as @Buyandhold2012 will tell you to never sell a stock. Much of his gains are courtesy of his big winners that make up a considerable portion of his portfolio. His portfolio is certainly bent out of shape, but in a good way he would tell you. Buyandhold had reported that Abbott Labs and AbbVie are now about 20% of the common stock portfolio. Exxon Mobil is about 16% of it. And Philip Morris, Altria, Kraft Heinz and Mondelez are about 20% of the portfolio.

I've talked to many successful stock investors who report the same event - their winners have ruled the day and they are richer for the experience, and they are happy to let them run.

And while you may not be absolute in the buy and hold forever mantra, perhaps you might need to be less picky about rebalancing thresholds. That might save you considerable sums in taxable accounts where you would obviously be trimming the winners with considerable gains.

Rebalance on the fly.

In the accumulation stage when you are adding new monies and have portfolio income to reinvest, you might be able to keep the portfolio more finely tuned by adding monies only to the laggards. I added monies to my laggards and my portfolio is not as bent out of shape as the example above where I had listed the drift percentages.

This is just my opinion, but as self-directed investors, I think we can get away with a little less directing.

Author's note: Thanks for reading. Please always know and invest within your risk tolerance level. Always know all tax implications and consequences. If you liked this article, please hit that "Like" button. Hit "Follow" to receive notices of future articles.

Disclosure: I am/we are long BNS, TD, RY, AAPL, BCE, TU, ENB, TRP, CVS, WBA, MSFT, MMM, CL, JNJ, QCOM, MDT, BRK.B, ABT, BLK, WMT, UTX, LOW, NKE, TXN, PEP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.