Way Down, Way Up, Rebalance!

by Fran Kinniry, Vanguard Investment Strategy Group

Since the U.S. stock market hit bottom on March 9, 2009, during the Great Financial Crisis (GFC), the S&P 500 Index had risen a stunning 248% as of the first quarter of this year. In little more than six years, the present bull market has broken several records and surpassed history’s larger bull markets, reaching its current third-place rank among the top 10.

If that wasn’t already astonishing, given the mood about the equity markets post GFC, the S&P 500 is within striking distance of becoming the second-largest bull. If it breaches 2,486, it will bump the 1949–1956 bull market to third place.

Keep on guessing

Very few investors could have conceived such advancement during or after the GFC. Prognosticators will champion their prescience, but such heights were hard to see from the depths of the financial crisis, when the glimmer of return on risk-taking was anything but certain. But out of the third-worst bear market, the extremity of the stock market flipped.

Clients who abandoned their plans, believing they could get back in when “the coast is clear,” likely suffered equity losses without the benefit of fully participating in the recovery. It’s a humbling mechanism for those who believe they “know” the market’s next move.

While the financial crisis shook the confidence of almost every investor, regimented rebalancing is within your clients’ control. One of the key value propositions of the advisory relationship is behavioral coaching, which includes helping investors “stay the course,” especially when the financial markets look their darkest or their brightest.

The extremities of such sharp market swings in recent years do not mean that stocks will continue upward, nor do they mean that a sharp sell-off is imminent. What they do mean is that the stock market is unpredictable, especially in the short run, and moves in great magnitudes. This is the equity risk premium that investors get compensated for.

While new market milestones often inspire prognostications, those forecasts bear little relevance to your clients’ long-term success.

So what is an investor to do? I would start with reaching out to your clients to review their asset allocations. If they’re like most investors (i.e., with an equity-heavy portfolio), new cash flows will likely need to be directed to bond mutual funds, which is the exact opposite of what many are willing to do today.

Rebalancing: Asset allocations show trend following

Remember, rebalancing is not about maximizing returns, reversion to the mean, or market forecasts—it is about maintaining the risk-and-return characteristics of the portfolio an investor selected based on his or her unique time horizon, risk tolerance, and financial goals. In contrast to market predictions, rebalancing is within your clients’ control.

With the U.S. stock market up 248% from the trough, it is understandable that your clients may have a hard time selling stock funds and committing more capital to bond funds. But if those sentiments are the same as the ones from the last bull market and, conversely, reminiscent of the ones following the GFC, a wider perspective of the market’s volatility may be just what your clients need to convince them that this time isn’t all that different.

Notes:

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index. Visit vanguard.com for updated Vanguard fund performance.

All investments are subject to risk, including the possible loss of the money you invest.

There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Diversification does not ensure a profit or protect against a loss.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market with the assistance of a stockbroker. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

© 2015 The Vanguard Group, Inc. Used with permission.