Time to Rebalance in May and Call It a Day

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The old stock market adage "Sell in May and stay away" suggests you can avoid risk and increase return by getting out of the markets during the summer.

Seasonal investing hit a high after Sven Bouman and Ben Jacobsen's 2002 study. The drop in the markets that summer also contributed heavily to the trend. Between 1950 and 2002, returns for November through March averaged 9.06% versus only 3.18% between May and October. Since 2002, however, the trend has been more muted. The recent difference between these numbers is statistically small for the wide range of returns.

The advice to rebalance appears this time of year whenever the markets have appreciated over the previous six months. Getting out of the markets entirely is generally a losing bet. Given their volatility and the strength of seasonal psychology, there may be some months when markets perform better. But that doesn't mean Treasuries can outperform stocks from May through October.

Setting a target asset allocation is the most critical part of investment management.

Rebalancing, however, is always a wise idea. Setting a target asset allocation is the most critical part of investment management.

Asset allocations can be set for a number of personal reasons. But the first customization is based on the age of the younger spouse. When you are young and actively adding at least 15% of your income to your investment portfolio, you do not need much allocated to bonds, the stability side of your portfolio.

Later in life, the percentage of your portfolio you are contributing each year declines compared to the amount your portfolio is appreciating each year. At that point, adding more to the stability side helps smooth portfolio volatility. It also adds dry powder to the appreciations side when the markets correct sharply.

Many investors believe they should switch to interest- and dividend-paying investments around age 65 to ensure sufficient retirement income. But from an investment point of view, a stock that appreciates 6%, a stock that provides a 6% dividend and a bond that pays 6% interest are equal.

Safe spending rates are often lower than the interest, dividends and appreciation generated. If you spend all of your growth, you are spending too much. Your portfolio's purchasing power will dwindle with inflation. Your retirement will be jeopardized.

The percentage of stable bonds should remain relatively low at age 65 and cover about five to seven years of safe spending rates. At age 65 the percentage in stability should be about 25%. The remainder of the portfolio, with a time horizon of 8 years or longer, should be invested in appreciating assets to keep up with inflation.

We use six different asset classes: three for stability and three for appreciation. We divide the asset classes for stability into short money, U.S. bonds and foreign bonds. We divide appreciation into U.S. stocks, foreign stocks and hard asset stocks. Hard asset stocks are not the same as investing directly in commodities. They are companies that own and produce an underlying natural resource. These include oil, natural gas, precious and base metals, and resources like real estate, diamonds, coal, lumber and even water.

Most investors have primarily U.S. large-cap stocks, mimicking the S&P 500, and U.S. bonds. We call this an asset class and a half. This is not a well-diversified allocation.

To rebalance your portfolio, you first need an asset allocation to rebalance back to. Here are some age-appropriate asset allocations using our six asset categories:

Short Money
U.S. Bonds
Foreign Bonds
U.S. Stocks
Foreign Stocks
Hard Assets
30 3.0% 2.2% 2.2% 36.2% 40.8% 15.6%
40 3.0% 5.8% 5.8% 32.2% 36.2% 17.0%
50 3.0% 7.7% 7.7% 30.0% 34.0% 17.6%
60 3.0% 9.7% 9.7% 27.9% 31.5% 18.2%
70 5.0% 13.6% 13.6% 22.8% 25.8% 19.2%

These are just suggested starting points. There are many reasons to adjust an asset allocation recommendation based on your personal situation or market conditions.


You can implement an asset allocation with your current favorite investment choices. Simply assign each investment to one of the six asset categories. Sometimes a fund may be split between two asset categories. For example, a global fund might be 60% foreign and 40% U.S. companies. Simply divide the fund across those two asset categories. Analyzing your portfolio against your age-appropriate allocation will show where you might adjust your investments.

In the past I described a "gone-fishing" portfolio of six long-standing mutual funds. Today, however, I suggest exchange-traded funds (ETFs). You can easily combine the six ETFs listed here with the age-appropriate asset allocation models in the chart to create your own easy-to-implement gone-fishing portfolio.

Add all of the stability percentages in the first three columns and invest in a bond ETF. Use the Vanguard Total Bond Market Index (BND) or the iShares Barclays Aggregate Bond Fund (AGG). We do worry about rising interest rates hurting longer term bonds and try to keep bond duration short. But the whole point of a gone-fishing portfolio is letting go of those kinds of concerns.

Take the percentage allocation to U.S. stocks and invest two thirds in mostly large cap and one third in small value. For large cap, a broad market fund is better than just the S&P 500. Use Vanguard Total Stock Market Index Fund (VTI) or iShares Russell 3000 Index Fund (IWV). For U.S. small value you have a plethora of choices. You could use the Vanguard Small-Cap Value Index Fund (VBR) or the iShares Russell 2000 Value Index Fund (IWN).

Next take the percentage allocation to foreign stocks. Invest two thirds in developed countries and one third in the emerging markets. For the developed countries, use Vanguard MSCI EAFE Index Fund (VEA) or the iShares MSCI EAFE Index Fund (EFA). For emerging markets, use the Vanguard Emerging Markets Stock Index Fund (VWO) or iShares MSCI Emerging Markets Index Fund (EEM).

Finally, put the allocation to hard asset stocks in iShares S&P North American Natural Resources Sector Index Fund (IGE).

The mostly iShares ETF portfolio has performed exceptionally well over the past five years. The S&P 500 only averaged an annual 2.62%, whereas this portfolio averaged 6.10% through the end of March 2011. And the expense ratio is only 0.36% compared to typical mutual funds expense ratios of around 1.20%.

The Vanguard ETF gone-fishing portfolio performed equally well returning 6.08% over the past five years. Also, it has an even lower expense ratio of 0.19%. We prefer the Vanguard funds.

You can view a Morningstar analysis of these two funds and have a look at our original gone-fishing portfolio at  www.emarotta.com/gone-fishing on our website.

It is always a good time to have a balanced portfolio. But even going fishing requires regular rebalancing. And now is the time to balance or rebalance your portfolio. Rebalance in May and call it a day, and please remember again in November.

Marotta Wealth Mangagement, Inc. of Charlottesville provides fee-only financial planning and asset management. Visit www.emarotta.com for more information. Questions to be answered in the column should be sent to questions@emarotta.com or Marotta Wealth Management, Inc., 1000 Ednam Center, Charlottesville, VA 22903-4615.