Pittsburgh Penguins' Sidney Crosby shoots as Boston Bruins' Charlie McAvoy defends during the second period of an NHL hockey game, on April 13 in Pittsburgh.Matt Freed/The Associated Press
In the world of hockey, few players have achieved the legendary status of Sidney Crosby. His tenure with the Pittsburgh Penguins has been nothing short of remarkable, filled with countless accolades and multiple Stanley Cup victories. However, as the saying goes, all good things must come to an end. At 36, he is still a force on the ice, but the Penguins now find themselves at a crossroads, facing the harsh reality that their beloved captain may soon have to move on.
As investors, we can draw valuable lessons from this predicament. Just like the Penguins, our investment portfolios require careful management and the ability to adapt to changing circumstances. The Penguins’ reluctance to acknowledge the need to revitalize the team mirrors the complacency that can creep into our own investment strategies.
Just as a successful hockey team requires a balanced lineup of offensive firepower, defensive grit, and solid goaltending, a well-constructed investment portfolio demands a diversified mix of asset classes working in harmony. And just as a coach might adjust their lines and strategies based on the game’s ebbs and flows, investors should regularly rebalance their portfolios to ensure alignment with their goals and risk tolerance.
This is where portfolio rebalancing comes into play. By periodically adjusting the weightings of various asset classes, investors can maintain their desired risk/reward profile and avoid the pitfalls of overexposure to any single investment. As research by the Vanguard group shows, a well-balanced portfolio can weather the storms of volatility much better than one that’s too concentrated in a single asset class.
Other researchers have compared two styles of investing: the rebalanced approach, and the “chase” portfolio, so named because it focuses its investments on last year’s best-performing asset class in a bid to get the same kind of returns. The study found that for any rolling 20-year investment time horizon, the chase portfolio had relatively weak returns. And that’s for a portfolio that carries a relatively higher risk. Only annually rebalanced portfolios with the most conservative asset allocation provided lower returns than the chase portfolio.
Of course, others point out that rebalancing comes with trading costs and therefore reduces returns. That would be the equivalent of saying that trading Mr. Crosby now, while he is still making a valuable contribution, makes no sense. But in a few years, there might very well be no value for the Penguins in trading him and no money to reinvest in the next generation of talent. Rebalancing portfolios for investors is not about increasing returns but reducing the effect of declines during market downturns and positioning your portfolio for the next market cycle.
Industry research does support the view that regular rebalancing can help minimize volatility and potentially improve long-term returns. Rebalancing can also help investors avoid the pitfalls of emotional decision-making. Other research highlights that, without a predefined rebalancing strategy, investors may fall prey to behavioural biases, such as chasing recent winners or avoiding underperformers – a sure-fire recipe for buying high and selling low.
Yes, rebalancing comes with costs, including transaction fees and potential tax implications. However, the benefits of active rebalancing can far outweigh these costs, particularly when it comes to maintaining an investor’s desired risk/reward ratio and avoiding costly mistakes. By limiting rebalancing actions to once a year, and only if the imbalance is greater than a certain threshold, investors can further limit the transaction and tax costs while maintaining the benefits of regular rebalancing.
So, just as a hockey team requires a balanced lineup to succeed for the long term, a well-diversified and regularly rebalanced portfolio is essential for long-term investment success. By trimming winners and bolstering laggards, investors can keep their portfolios aligned with their goals, reducing risk, and potentially enhancing returns – a winning strategy both on and off the ice.
Sam Sivarajan is a speaker, independent wealth management consultant and author of three books on investing and decision-making.