Rebalancing and diversification are terms you’ve likely heard us mention more often than you'd care to hear—but with good reason. These essential strategies help our clients stay on track to achieve their financial goals. Each play an important role in managing the risk in your portfolio, ensuring you have the resources to meet your current needs while growing the funds necessary to reach future objectives.
As our team is busy rebalancing client portfolios to start 2025, now is a perfect time to see this in action and see why we do it in the first place. The 21st century, while only being a quarter of the way through, has provided two great case studies and examples of diversification and rebalancing in action. Let’s dive in:
Example 1 – “The Lost Decade” January 1, 2000 – December 31, 2009
The new millennium started pretty rough for stock investors, starting with back-to-back-to-back negative years out of the gate, then capped off with the Financial Crisis in 2008. This timeframe has been dubbed “The Lost Decade” as an investor in US based stocks on January 1, 2000 had actually lost money by December 31, 2009. If you had $1 million invested in US stocks to start the decade, you had $908,579 at the end, nearly -1% per year. Not great.
Investors who maintained a diversified and regularly rebalanced portfolio performed better over this time. For example, an investor with a 60% allocation to US stocks and 40% to US bonds who rebalanced at the start of each year saw their portfolio grow by 2.58% per year, turning a $1 million investment into $1.29 million over the decade. Adding international stocks as a third asset class further enhanced returns. A portfolio with 48% US stocks, 12% international stocks, and 40% US bonds achieved an annual return of 2.98%, growing $1 million to $1.34 million during the same period.
What if the diversified investor had invested their money on January 1, 2000, and left it untouched for 10 years without rebalancing? In the 60% US stocks, 40% US bonds portfolio, the annual return would have been slightly lower at 2.53%. More importantly, the portfolio's allocation would have shifted significantly. By the end of 2009, it would have been 42% stocks and 58% bonds, deviating far from the original target. Adding international stocks tells a similar story. The annual return would have dipped slightly to 2.92%, and the portfolio's allocation would have shifted to 33% US stocks, 11% international stocks, and 57% US bonds. This highlights the impact of neglecting rebalancing—not only in returns but also in maintaining the intended asset mix.
The tale of the tape:
- 100% US stocks: -0.95% per year
- 60% US stocks, 40% bonds: 2.58% per year
- Without rebalancing: 2.53% per year
- 48% US stocks, 12% international, 40% bonds: 2.98% per year
- Without rebalancing: 2.92% per year
Example 2 – The Previous 10 Years: January 1, 2015 – December 31, 2024
The past decade couldn’t have been more different from the one that began this century. While US stocks struggled in the 2000s, they have been the clear winners over the past 10 years, vastly outperforming international stocks and bonds. Let’s revisit the scenarios we analyzed earlier, now focusing on this timeframe:
An investor who allocated $1 million to US stocks on January 1, 2015, would be very pleased by the end of 2024, as their portfolio grew to $3.34 million. Meanwhile, diversified and rebalanced investors saw lower returns during this period. A 60% US stock, 40% bond portfolio, rebalanced annually, grew at an average annual rate of 8.35%, turning $1 million into $2.23 million. A portfolio with 48% US stocks, 12% international stocks, and 40% bonds grew at 7.49% annually, reaching $2.06 million.
Rebalancing continued to play a crucial role during this period. If the 60% US stock, 40% bond portfolio had been left alone, it would have delivered a higher return of 9.42% annually. However, by the end of 2024, the portfolio would have shifted to 82% stocks and 18% bonds. This change significantly increased the risk level, leaving an investor expecting a moderate risk profile exposed to much higher risk than intended. Adding international stocks again follows a similar trend. While the annual return increased to 8.55%, the portfolio’s allocation shifted to 71% US stocks, 9% international stocks, and 20% bonds.
The tale of the tape:
- 100% US stocks: 12.83% per year
- 60% US stocks, 40% bonds: 8.35% per year
- Without rebalancing: 9.42% per year
- 48% US stocks, 12% international, 40% bonds: 7.49% per year
- Without rebalancing: 8.55% per year
The takeway:
It is important to note that these are very simplistic examples and only shows two very specific time periods. It ignores market fluctuations and rebalancing opportunities mid-year (i.e. 2020), diversification and rebalancing within each asset class, and any additions or withdrawals from the portfolio through those times. In reality, a lot more goes into each process.
Regardless, diversification and rebalancing are vital for managing risk and optimizing returns. These strategies help you capitalize on favorable market conditions while providing protection during downturns. Although maximizing investment returns is always a priority, doing so at the cost of significantly increased risk is not a sound approach and could jeopardize your entire financial plan.
Biden Signs Social Security Fairness Act
In one of his final acts as President, Joe Biden signed the Social Security Fairness Act into law, eliminating two controversial Social Security provisions – the Windfall Elimination Provision (WEP) and Government Pension Offset (GPO). While the vast majority of Americans may not have even known these two provisions existed, they have been a major source of contention for the nearly 3 million Americans who were impacted by them
This change affects teachers, firefighters, police officers, and other public sector workers who receive both a government pension and Social Security income. Previously, if you worked in the public sector, earned a pension from that work, and qualified for Social Security benefits, your Social Security payments were reduced because of the pension income. In 2024, the maximum reduction under the Windfall Elimination Provision was $587 per month. With the elimination of this provision, affected individuals will now receive their full Social Security benefits without any reduction.
The Social Security Fairness Act will affect Social Security benefits payable after December 2023. Any Social Security recipients who were impacted for 2024 will receive a lump-sum payment to make up for the shortfall in benefits in 2024. Details on how the benefit increase will be implemented going forward have not been released.
CNBC – Social Security Fairness Act Brings Retirement Changes For Nearly 3 Million Public Pensioners
CNBC - Biden Signs Bill To Increase Social Security Benefits For Millions Of Public Workers
SSA.gov – Windfall Elimination Provision
SSA.gov – Government Pension Offset
This Week’s Economic & Market News:
Yesterday, we had economist Fritz Meyer join us on a webinar where he shared his perspective and insights on the state of the economy, markets, and investment strategy. We will have a replay available for those that weren’t able to join us for the live version. Be on the lookout for an email containing the replay information.
I can’t even begin to touch the amount of experience and information that Fritz brings. So, I highly encourage everyone to give him a listen, and I will keep the economic focus of this week’s newsletter to a few highlights:
- November Jobs Data Released – The latest report showed some signs of softening in the labor market, indicated by an increase in job openings and lower hiring and quit rates. Layoff rates remained unchanged, however, a positive sign as many economist worried labor cuts would increase to control costs. Reuters WSJ
- Long term bond yields continue to rise – The 10-year US Treasury yield is hovering around 4.7%, its highest level since late 2023. This yield serves as a key benchmark for long-term lending rates, including mortgage rates and corporate borrowing costs, and is widely viewed as an indicator of market expectations for future economic growth and inflation. An increase in the yield typically reflects expectations of higher inflation and stronger economic growth. CNBC
Quick Hits:
- Wanting to add value to your home before selling? Here are the projects you should prioritize: WSJ – Home Sellers Renovation Tips
- A rare feat – The gamblers won. FanDuel sports betting parent company cut its revenue projections as NFL betters won too much. Morningstar - FanDuel's parent company just issued a profit warning. Blame the Detroit Lions
- Dreaming of warm places as it feels like 2 degrees outside as I write this. Travel and Leisure - 15 Best Warm Places to Travel to This Winter
- Or if you want to stay in New England, here are some fun, unique stays Time Out – 21 Best Airbnbs in New England
Quote: “Be a friend, tell a friend something nice. It might change their life.” – Pat McAfee
Thank you for reading RSWA Financial Advisor Insights! We welcome feedback, and please forward this to a friend! Be well, take care, and stay safe!
