Brent Everett has spotted a pattern.
“Clients often resist the rebalancing decision when a certain asset class shows a lot of upward momentum,” said Everett, founder, chief investment officer and partner at Talis Advisors in Plano, Texas. “In fact, it’s not uncommon for them to want to add to that asset class, which can push the overall risk of the portfolio well outside of their risk tolerance.”
How does Everett cope with such a reaction?
“We explain that rebalancing is simply a systematic way of buying low and selling high, exactly what we all know makes sense,” he said.
Talis Advisors also defines the purpose of rebalancing: “To limit risk, not to add to return,” Everett said.
Of course, it isn’t the first time that Talis Advisors clients who resist rebalancing are hearing that notion.
“This is a concept that we discuss with our clients when we develop their portfolio, and it’s also explained in the investment policy statement that we create for them and that we have mutually agreed upon,” Everett said.
That said, sometimes clients need more than reminders to overcome their resistance to rebalancing, he said.
“There are certainly times when a client may resist selling a specific position for sentimental reasons,” Everett said.
The more aggressive push-back from clients happens when an asset class is performing well and the tax consequences of making capital gains causes concern for them, he said.
“Most frequently, we see situations where a position may be held due to the desire to manage realization of capital gains,” Everett said.
Such situations lead to a choice.
“A tradeoff between tax impact and diversification benefits has to be considered,” Everett said.
In such instances, "rebalancing can be a difficult decision," he said.
"In the absence of the proverbial crystal ball that allows us to see into the future, we generally advise clients that it’s most important to control risk,” Everett said.
“We run into this every week,” Tim Courtney, chief investment officer for Exencial Wealth Advisors in Oklahoma City, said about clients resisting rebalancing proposals.
Typically, clients resist when a certain asset class has positive or negative momentum or when the price of an asset climbs or drops, he said.
His approach is to tell them to think about the “accommodating” philosophy espoused by the late Benjamin Graham, an economist who taught and then hired famed investor Warren E. Buffett, prior to his Berkshire Hathaway days.
Under such an approach, investors accommodate the market, selling when the market is “begging” by offering high prices and buying when others are saying no by offering low prices.
That theory puts the investors in “the driver’s seat” and helps them overcome objections to rebalancing, Courtney said.
But it still isn't easy.
“Rebalancing [is] not intuitive. It’s counterintuitive,” Courtney said.
This story is part of a 30-30 series on building a better portfolio.