Hello and welcome back to the life by design podcast. I'm here again with Doug Walters, our CIO at strategic.

Hey, Jay, how are?

You doing fantastic. So today we're going to do another little bit longer form with Doug. We're going to go through our weekly insights that Doug and Team wrote from the previous week and then we are going to dive into. A topic that we've brought up multiple times and I I want to know more about it and and I'm sure you at home want to know as well so but to start start us off. You know, Doug, you kind of pointed out a lot of coincidences around the number 10 this week in weekly insights.

Right. Yeah. And it's one of those things when you're, you know, you're just searching for what to write about, what's interesting. And I like to look at the numbers in detail. And I noticed that we are up 10% when when I say up the. U.S. stock market is up 10% from the recent bottom and it is still 10% below the peak that we had in February. But all that said and when we look over the last year or so, the last 12 months. Stock market is up 10%. So just this coincidence of of 10S came out in the.

Numbers. Yeah. And you know, when you brought that out and I was thinking about it too is. That. It's interesting because when those correlated, you know those numbers correlate like that. Sometimes in in my brain. Being someone that's not like highly intuitive with math is that. You know, if it goes down 10% and then comes back up 10% that those aren't equal numbers because the the total changed, right and yeah, so I was like very much contemplating that and like trying to swim through those waters of 10% changes and go well, I don't know what any of that actually puts us.

That's right, yeah. Exactly. Right, yeah.

At.

The market goes down for 10% and then goes up 10%. You're still below where you started, right? But yeah, the the big picture that not in those 10% numbers is you know from the peak to the through, we were down about 20% and that's where you know we've climbed roughly halfway up from that 20%, which is why we are. You know, 10% up from the bottom and roughly 10% down from the peak still.

1. Yeah. Yeah. So. So just for those at home, if you were wondering too, that was one of my big questions. And so I think part of that comes in and and I and then this is going to go into our bigger conversation is. With with those kind of lows, is diversification right? And being known, knowing that you're diversified during these times actually is going to help offset some of this volatility.

Right. Yeah. And if you are have a well diversified portfolio, you might be pleasantly surprised to look at your balance and realize you may actually not be down on the year. A lot of our strategies are actually up on the year because of that diversity.

Right. And like and I know it's one that we brought up multiple times, but with like the S&P still being down like a little bit over 6%, gold is up 25%, right? And that's one of those balancing acts that we're we're doing.

Right. Yeah. And international is is up significantly relative to the US as well. So there's multiple pieces of that diversified portfolio that have actually done well so far this.

Year. Yeah. And I think I think it's something we've said multiple times, but we're saying. And. That you're not trying to tell the future, you're just trying to be prepared for it.

Right, right, exactly. We didn't predict that gold was going to continue to outperform. It was still screening positively on our the the screens that we do. That's why it's in the portfolio. But it wasn't a prediction, it's just a part of a well diversified portfolio.

1. And so before we get into our main topic, is there any? Kind of things coming up in the next. In the next week or stuff that we're going to be keeping an. Eye on or that that anybody should be. You know, be be aware of.

Right. Yeah. And we've, you know this week we've seen the continuation so far of the rally that ended that we ended on last week and that's come as a result of some, you know, lightening up on the. Tariff discussions, I think there's still a lot to be determined on that front, but we've seen anyway some loosening of those tough that tough tariff talk and so that's helped. And then tomorrow we have an inflation number coming out. PCE inflation is the one the Fed tends to spend the most time looking at and is one of the most relevant. Economic pieces of economic data that comes out. So we'll be looking at that tomorrow and probably by the time this podcast comes out, it will be. It'll already be out, yes.

Yeah, it'll be yesterday. Yeah. OK. And so, so now we're getting into our main topic. And and this is, you know, for our listeners at home. This is something for me to understand as well as I speak with Doug and the team and one of one of the big topics that always comes up that I realized. Maybe I I didn't know enough about was portfolio rebalancing and and what exactly it is.

Right. Yeah. So we'll. We'll get into that today and you know, at a very high level, the purpose of portfolio balancing rebalancing is to keep someone within the appropriate risk allocation, right. So we assign a risk allocation to our portfolio and then we want to make sure that the client stays well within the the range of the.

Risk. And so I guess when you say risk in regards to a client, what what does that, what does that entail and what does that?

Mean, right? So for each client we want to work with them to understand. What is their sort of willingness to take risk, but also as advisors? What is their ability and sometimes what is their need to take risk and they may need to take a little bit more risk than they're willing. To take so we're trying to balance that equation and by risk, we mean you know what essentially you know how comfortable are you with the ups and downs of your portfolio, the more risk you take, hopefully the more reward over time, but you're going to get more significant ups and downs. You can't get the higher returns without a little more. Utility along the way. So we're trying to strike the right balance for each client based on again, their both their willingness and ability. And just to put a little more color on that, especially ability someone who is relatively young has a long investment horizon, has good stable income. They have the ability. To take on a lot of risk, whereas someone who maybe is living more on, say, a fixed income has a, you know, shorter. Potential lifespan. Perhaps they're there. Maybe don't have the same ability to take risks, so we'd want them in a more conservative portfolio.

Hmm.

1. So it's not just my what I want, it's also what I need from a financial perspective, let's say like towards retirement. Right. So if as an extreme example, if someone. Maybe only X years out from retirement, and they're closer than a 20 something, but they haven't for whatever reason, haven't really been able to save for retirement. Then they're they would have to almost have to take a higher risk in order to to. Get the gains that they would need to to do what they have to do for retirement.

Right, right. Yeah, we've, you know, obviously would work with them to try to, you know, minimize the expense side of the equation so they can.

Yeah, yeah.

You know, live that comfortable retirement, but they may need to be taking a little bit more risk in order to get them through retirement. Somebody who maybe has reached retirement very comfortably has a nice nest egg and just is like I I just don't want to ride the ups and downs of the mark. They have the ability probably to take a lot of risk if they've got a big nest egg, they just don't have the willingness and they don't have the need to. They can just, you know, ride out the income of that portfolio. The rest of their retirement.

Yeah. Right. Yeah. And so, yeah, I just. Yeah, that the word risk is. Always like kind of has a negative kind of, you know, feel to it. And so like, I just wanted to understand that cause I was like, I know risk, you know, so I hope for you at home that that kind of explained it so so we look.

Yes.

We look at that, that profile, right that we've we just kind of walked through some examples, extreme examples on either end. But we walked through some examples of what a a quote UN quote risk profile would look like for an for a client or an investor. And then we then apply what we call portfolio rebalancing. To make sure that we're within that risk profile overtime.

Right. Correct. Right. Yeah. So and there's different types of rebalancing that you can do, but the the idea generally is over time, you know different assets are going to perform differently. And your risk allocation will change. So typically let's talk, you know, at the most basic level, right, stocks are more risky than bonds. Stocks tend to go up more over time than bonds. If you just leave it alone, you do nothing. Stocks will become a bigger and bigger part of your portfolio. Your portfolio will become more and more risky.

Yeah.

And that may not be in your best interest. We're going to want to rebalance and make sure that you stay within an appropriate risk allocation.

1. And so with that? Like some examples could be that you know if I'm at a higher risk. There is the potential upside that I could have could quote UN quote, right, have this larger portfolio because I took the risks to to do it. But I also could have a smaller portfolio because I took the risks and they then and then if I just stay in that zone of. High risk, high reward. It won't be as balanced towards the end.

Right, right. You're going to want to keep stay within an appropriate risk level for you. And I was trying to think, Jay, like how can I put this in terms that Jay would really, you know, would really resonate with him. And I was thinking of collectibles and I, I don't know. That you mentioned the other day, you have a star. Wars collection, yeah.

Yeah, just for everyone at home. I'm a super nerd and yes.

And I'm imagining I'm imagining there's other collections as well.

Yep.

And so let's say that Jay is like, I'm just going to tie up my entire net worth in my collection, OK. And so you put, you know, 25% in your Star Wars collection and 25% in, I don't know. You tell me what else might these?

Yeah. Yeah, magic the gathering. Yeah.

All right, so magic the Gathering and 25% in two other, you know, different collectible buckets. And you're like, I'm really comfortable with the long term outlook of all four of these. And so I kind of want to own them in equal parts and over time.

Yep.

MHM.

They're going to perform right differently. The value of these collectibles are going to change in different amounts. So let's uh, let's say Star Wars, right? So Star Wars over time is getting more and more popular the further away we get from, you know, the the 1970s.

Yes.

And some of these, you know, toys first came out. They just keep going up and they become very popular and suddenly. Star Wars is now 50% of the value of your you know your net worth, right? 50% of it is tied up in Star Wars. Now, that's risky, right? And so Jay has not been rebalancing right. He has just been buying and holding. And so that's the risk and.

Yeah.

Let's imagine something. Thing. Something happens right to the the brand of Star Wars, you know George Lucas was, you know, hiring child labor.

Yeah.

The yeah, yeah. During the filming of Star Wars. And suddenly, yeah. Yeah. And suddenly Star Wars is paraphernalia is not worth anything. Right. That was a huge risk. Now 50% of your your portfolio is worthless. So that's the risk of not rebalancing at all.

Hmm, OK.

So that's. Not rebalancing. The sort of next step in rebalancing, sort of what a lot of firms out there are doing very common is what's called calendar based rebalancing, OK, OK. And for this continuing with our example, yeah, you know, you're going to be pricing out the value of your collectables every year and every year you're going to look and say all right. Star Wars has done much better than. Everything else. So I'm going to sell some of my Star Wars collectibles down to a level where it's equivalent to the others. I'm going to use those proceeds to buy some of the others. I still love all of these collectibles, right? Equally, I find, you know you have equal confidence.

Equally, yes, yes. Yeah, yeah.

Right, that they're all going to be do well. They're all a good part of your portfolio. So you're going to sell some Star Wars and put it in some of the other collectables, OK? And that's calendar based rebalancing and that.

OK.

Is. It is good, it is value added.

OK.

But it is not the best thing you can.

Do OK.

For your rebalancing.

All right. So I so now which would lead me into the next thing which is the one we talk about a lot is opportunistic rebalancing.

Then correct. OK, right. And so to take this analogy.

Even further, love it.

Even further. Yeah. OK, so you've got your 4 equal buckets of collectibles. And you are not watching these once a year and not valuing them once a year. You're watching them every week and you're not just watching, you know, how is Star Wars doing but you're looking at each individual piece that you own? And let's say you know some news comes out that ohh, we just realized that, you know this Luke Skywalker figure. Seen had you know, you know, there were some like manufacturing defect on some of them that we never knew before, right. And Jay looks at his and realized, oh, I've got one of these and suddenly this $100 figurine is worth $2000. And so Jay sees that. Because he's looking every week at these and he's like, you know what? I'm going to sell this Luke Skywalker figurine for $2000. And rebalance My Portfolio so opportunistic rebalance is looking every week at every asset you own to see if something jumps out of a normal band. OK. OK. So in this case the, you know, the loose Skywalker figurine. Jumps out. You're like alright, I need to sell that. That is way too valuable. And then buy something else that is, you know, hasn't performed. You know you're looking for your worst performer again. Things you still believe in. Yeah, things you think are going to work in the long term. Just haven't materialized.

Yet right something. Like I know will hold its value but it it just hasn't jumped to like that. Luke, the Luke Skywalker example did because of something that was found.

Out. Right. OK. And if we kind of tie that into? Say that the last couple weeks, right, we have seen some significant moves in the market and we saw. Saw a market that fell 20%. And then within a couple of days, let's say, it fell 10%. And then within a few within a week. So that week of March 31st, I think it was. Market fell significantly, stocks underperformed bonds by like 10% in a week. We were looking at that performance. Identifying that stocks were suddenly much cheaper than they were a week ago, we had the opportunity to opportunistically rebalance, buy something or sell something that held its value, most likely gold, and then buy those stocks that underperformed the next week.

M.

Stocks outperformed bonds by 8%. We saw a huge reversal, so opportunistic rebalancing is never going to get that perfect, but it has the opportunity to catch those one off moves and you know to put it in you know back into the the analogy you know imagine that. You know you've sold your Luke Skywalker and then news comes out. Ohh, you know that wasn't actually, you know, manufacturing defect. They all have this thing. And you're Luke Skywalker is down back down to $100. You got rid of it for $2000 because you were looking every week.

OK, so I that's great. That actually is perfect explanation for me. So so a lot of that was explanation was in the first person of of me doing this and looking at this so for. Clients that you know utilize our services that how do they see this rebalancing when they're looking as almost the third person view right of cause because we're doing that for them. From a week to week basis or or however often, and so how did they see it from their viewpoint?

Right. Yeah. So we are obviously doing that work on their behalf. We're looking at every account, every security to see if it has gone outside of a, what we call a rebalancing band. So when something does. Trigger, they're going to see a cell of that outperforming asset and the corresponding buy of some underperforming assets. And so they will see trades in their account, right. And they might wonder what's what was this? What's this tactical? A lot of times it is you know, more often than not it's not tactical, it is simply. Rebalancing systematically selling high and buying low and we will get questions. You know right now for example our primary. Source of funds, meaning what we are selling is gold because gold is significantly outperforming everything else and so they will see us selling gold in their. In their portfolio and buying something cheaper, some cheaper equities that have underperformed and we'll get the question, you know why you selling gold? It's the best performer in My Portfolio and it's like, that's exactly why we're selling gold. We are locking in those gains for you, right? We're cashing in on that expensive gold and buying something cheaper that we still believe will outperform.

Yeah.

Over the. Long term.

Right. And I think that's the what is that bias fallacy? That it's the winners winners fallacy, where they're going to keep winning, right, and it's just if I keep putting the money in the slot machine, I'm winning right now. So if I keep reinvesting that into the slot machine, I'm going to keep on winning. And it's at some point that stops being true. Right. And So what we're trying.

Right. Right.

To do is just. Not predict that it's going to be true, but just say. Right. When we got into acts, it was at this dollar amount we the Luke Skywalker, I I, you know, maybe I bought it for $5 at the at the local swap meet and now it's $2000. That's the highest I've ever seen it and so I should take that money to put it into something else that I believe will will perform.

Right.

Right in the future.

Right, exactly. And.

And it could go up to. It could potentially go up to 3000, but it also could go back to $5 or 100 in your example.

Good. Yeah. Right. And so.

So just kind of like weighing that and saying OK, listen, we we got you know if I bought it for $5 and it sold for 2000, you know I got $1900 basically you know roughly out of it almost $2000. So now is a good time to reallocate that. OK.

Right. OK. There's a there's a subtle point here, which is also worth making. We talk a lot about momentum is one of the factors that we invest in. And you might say that seems. Contradictory to rebalancing momentum is buying things that are going. Up.

MHM.

And we do do that as part of our strategy. One of the factors that we buy is momentum, how opportunistic rebalancing factors that in is we set when I talk about those trade corridors. Those rebounds, corridors. We set them very wide. We're we're not looking for something that is outperformed by 1%. Two percent, 5%. We're looking for something that is outperformed by 20. Percent. Relative to everything else, and that's a big barrier, especially if everything's kind of moving, you know, to some degree together it takes a lot to outperform by 20%. And so we're not going to sell something immediately just because it did well, it has to be a significant outlier on the upside. Before we, we trigger that rebound. So we're taking advantage of that short term. Yeah, but at a point where, like it's gone too far, we want to take advantage of that.

All right. I think that all makes sense. So then I guess the, you know, we just kind of wrapped up. Well, for the most part, most people just wrapped up tax season and we're heading into a new year. And so one of the questions I had and I think comes up sometimes is what are some of the tax implications around rebalancing if if there are?

Any sure? Yeah. If you are in a taxable account and we are rebalancing, we're selling something that is done. Well, there's likely going to be capital gains on that sale and that is. Just. A. A cost of keeping your risk in check because the alternative is to not take the gains and continue to let your portfolio get further and further away from that risk allocation. For some individuals, they that might be the option they want to take, but you are taking significant risk. It is not out of.

MHM.

Out of the realm of possibility that equities can fall 5060% like that has happened in the past, so keeping your portfolio in check at the right risk allocation is really important and we do encourage our clients to you know, take that tax hit in order to keep their. Portfolio at the right risk.

Level. So I guess to bring it back to my collectibles, if we use that Luke Skywalker as a. Simple. Let's say you know, let's say somebody offered me if I want to sell it. Somebody offered me like 2300, but it was going to cost me two or $300 to ship it and prep it to get it out to them. I'm still making, you know? Yes, I'm. I'm off of the sale. I'm losing 2 or $300.00 from the shipping and handling.

Right.

But right, I'm still making all that money that I made to reinvest into other things that I didn't have. Before because I I only paid $5. For it or whatever.

Right. Yeah. You don't pay taxes on losses, right? So by definition, if you're paying a tax, it's because you've had a gain. OK, so, you know, take that gain, enjoy that gain. Pay the taxes that are necessary to keep you in the right risk profile.

1. Well that all makes a lot more sense to me. Yeah, I think unless you have anything else. Doug, I wonder if I don't know, is there anything else? You. That's that was a lot. So I'm feeling pretty good, yeah.

That, yeah, if that makes sense to you, then my job is done.

Here. Well, thanks, Doug, and I hope everyone at home. That bringing it into the world of Jay helps maybe make it more palatable to you. So if you guys have any. Questions. You can leave comments always on any of our videos or podcasts and and maybe if it's relatable, we can try to. We can try to ask it.

On the podcast. So alright, thanks Jay. Thanks.

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