How Advisors Can Assist Clients in Rebalancing Their Portfolio Over Time

Why this matters to clients

Portfolio rebalancing helps advisors uncover a new investment plan of action that aligns with a client's long-term financial milestones. It also considers how the current market will impact asset diversification. For clients, these actions matter, for the following reasons:

It minimizes emotional bias in the portfolio: A review of 31 different online studies finds that investment decisions and emotional biases have a strong correlation with each other. Advisors play a central role in removing emotion from the investment process. When rebalancing, advisors allocate new positions to underweighted assets, while looking to trim assets that are not serving the long-term objectives of the client.

It manages risk more effectively: Changing market conditions, coupled with political and social implications, bring a series of uncertain risks to any investor's investment plans. Keeping an open mind and looking towards opportunities that minimize risk while cutting back on assets that have grown disproportionately will ensure a more structured approach. Mitigating risk requires removing those investments that are not serving the forward-looking purpose and replacing them with more fitting options.

It provides exposure to low-hanging fruit: Rebalancing provides investors exposure to equities, bonds, or other investment vehicles that will offer them maximum upside potential throughout their transition. Depending on a client’s desired objectives, rebalancing should take place at least once per year. During the period of rebalancing, advisors should seek low-hanging fruit that are still within the framework of client needs, but offer better near and long-term return maximization.

It helps with tax-loss harvesting: Rebalancing helps to keep asset allocation in line with a client’s broader financial plan. Additionally, the process of restructuring the portfolio’s composition allows for an opportunity to take advantage of tax-loss harvesting, enabling the creation of more tax-efficient portfolios. Although taking advantage of tax-loss harvesting is often considered a more laborious process, the outcomes can align client portfolios with tax-efficient capabilities.

Advisors’ role in portfolio rebalancing

Portfolio alignment may change over the course of a quarter, several months, or perhaps a year. Advisors and clients need a hands-on approach that allows them to uncover how asset allocations can be adjusted and where more focus is needed amidst a changing market environment.

Quarterly portfolio analysis

Constantly checking portfolio performance can leave them feeling that assets are performing worse than they are. Whether it’s for performance or investment purposes, constant portfolio review can lead investors astray, causing them to make a wrong decision and costing them either short or long-term success.

This has been proven by some research that shows that roughly half – 49% – of investors check on their investments once per day. The surge in investment applications and digital stock brokers has seen many investors cultivating a habit of “high-frequency monitoring.”

To minimize the risk of high-frequency monitoring, advisors should meet with clients over a quarterly period. Though the breaks in between might seem too long or even too short for some investors, a quarterly review provides both advisors and investors with more relevant data that can be applied to their rebalancing approach.

Quarterly meet-ups should be seen as a regrouping exercise. They allow advisors to review portfolio performance, and ensure effective planning has been applied throughout the quarter to achieve certain goals. For investors, this brings an opportunity to remove uncertainty about their portfolios, and ensures that they have access to accurate data.

Scheduled reviews and check-ups

Not every client will prefer a quarterly or bi-annual review. In some instances, advisors will need to take more time to help navigate clients through the process of overcoming market uncertainty, which requires more on-demand actions.

One survey found that infrequent communication between advisors and clients may decrease financial confidence. In the survey, around 22% of clients who are rarely contacted (every four to six months or less) felt comfortable with their financial plan. This is compared to 71% of clients who receive frequent (monthly or more) reviews from their advisor.

Routine portfolio reviews and check-ups act as a psychological antidote for nervous investors – especially during a market turndown. These actions can also provide investors with better transparency and a more in-depth understanding of how current market fluctuations may impact their financial plans.

Having scheduled meet-ups can also keep clients informed about advisors' current and forward-looking decisions. This provides both sides more time to process and consider how changes will affect a portfolio, and what possible alternatives are available to choose from.

Scheduled portfolio reviews ensure that previous decisions can be reviewed and, should changes need to be made, allow advisors to take calculated risks to drive portfolio performance and return efficiency.

Communication and guidance

Financial advisors play an important role in educating clients about factors that could influence their portfolios and financial planning. Not only this, but advisors have the important responsibility of guiding their clients, whether that may be through market turbulence or a portfolio restructuring.

Proper communication is imperative to execute a successful portfolio rebalance. Advisors should ensure that clients are well-informed about key decisions that could have an impact on their long-term financial outcomes.

Education should provide clients with the framework they need to better understand the current circumstances, and how certain actions on their behalf will help them achieve their targets, align with their investment strategy, and minimize certain risks.

Providing clients with actionable advice, and having sufficient data to support these recommendations, will create improved client-advisor transparency. Further, the assistance of advisors enables clients to make more informed decisions independently. This guidance provides clients with the ability to invest in products they are comfortable with and fully understand. It also allows them to become more aware of their investment options, the risks involved, and what their guaranteed returns would be.

In addition, the process helps clients navigate through market challenges while conducting product evaluation, and leads them towards more efficient investment outcomes.

These actions will establish a guiding principle to assist clients in taking steps that won’t jeopardize their investments. Through advisors, clients can become more aware of underlying risks, including things such as investment fraud, online scams targeted at consumers and investors, high-pressure sales tactics, and digital financial threats.

Risk profiling

From the planning to execution, advisors need to provide portfolios with a consistent mix of assets to ensure a more balanced risk exposure. For starters, advisors should evaluate several key factors to determine a client’s level of risk tolerance.

Most importantly, a client’s investment objectives will provide a better understanding of potential risks a client may face throughout market changes. Next, the advisor should consult with the client to establish a time horizon for the portfolio. A long-term investment approach could potentially allow for more riskier investment options, while a short-term approach would place greater limitations on such allocations.

A client’s anticipated reliance on their invested assets plays an important role in evaluating how their risk appetite will change over time. Understanding how a client will use their funds could expose underlying risks that are not often taken into account in client evaluations.

Advisors must ensure that clients have exposure to a well-balanced blend of investment vehicles that remain within the client’s financial planning framework and do not drift too far from their strategic weights.

The evaluation process allows advisors and clients to determine how comfortable they are taking on different levels of risk. The outcomes will dictate future financial decisions, and ensure that forward-looking risk management is consistent with the client’s goals, preferences and comfort.

This is an opportunity for advisors to determine which risks are more acceptable, and how they can structure strategic portfolio actions to minimize these risks. This approach might require more critical resources at the beginning stage.

Tax-efficient rebalancing

Should a portfolio have a need for rebalancing, advisors should consider how certain asset changes throughout the year could impact the existing tax structure of the portfolio. For instance, increasing the number of high-return assets early on in the tax year could result in higher taxable earnings and lower the overall tax efficiency of the client’s portfolio.

Rebalancing is often best done in conjunction with tax-loss harvesting. This approach allows advisors to apply more tax-efficient planning, and minimize a client's tax liability. For instance, selling over-performing assets and buying under-performing assets could help align tax efficiency with a more sustainable long-term financial goal.

However, there is a “sweet spot” in terms of when to apply tax loss harvesting. In one study, the right time to harvest losses is during periods when investments have declined 10% for investors conducting monthly portfolio reviews, or 15% for those reviewing daily. This approach requires careful planning and long-term considerations based on current tax rules.

The objective is to ensure that clients are informed about the tax liability of their portfolios, and how strategic planning will potentially help lead them to better tax savings. As an advisor, you are in a position to consider all the different avenues and plan according to a client’s individual financial and retirement goals.

Long-term assessment and planning

Assessing each client’s needs will help advisors better understand where rebalancing is needed and which approach will work best based on individual long-term financial goals. To conduct a client's long-term assessment and planning, advisors must establish beforehand a relationship that allows clients to trust the advice and guidance their advisor provides. This concept is better known as the “trust theory” and can manifest in a positive way in two different scenarios, according to recent research.

First, clients who trust advisors are more likely to completely delegate responsibilities to the advisor, in this instance allowing advisors to better understand their long-term plans. Second, clients who trust an advisor are more likely to follow the advisor's recommendations.

Take into account the client-advisor relationship, and how openly a client is willing to delegate and follow an advisor’s recommendations. This will allow for a more personalized, forward-looking assessment. Keep in mind that a client’s needs will change over time. Advisors should have a clear picture and understanding of the near-term deliverables, as well as know which approach would be best-suited for their client’s portfolio balancing.

Planning for the unknown

Portfolio rebalancing is a way to plan for uncertainties in the market that have yet to unfold. These actions make it possible for investors to align their current investment strategies with longer-term financial goals.

There is no right or wrong time to rebalance a portfolio, and any changes to a portfolio will expose investors to various risks. These risks are generally more short-term. However, the outcomes should present a clear picture of how the changes affected the portfolio, either positively or negatively.

Throughout the year, advisors need to plan how they can meet client expectations while maintaining sufficient support for their financial needs. Planning and effective communication help to establish transparency among clients and advisors. Level-headed awareness can help uncover potential winners that will help bolster portfolio performance and deliver more positive long-term outcomes.

Thomas Young is an economist who builds models, researches the economy, advises on public policy, speaks at conferences, and enjoys thought leadership.

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