ATM: Using Volatility to Rebalance Portfolios



At The Money: with Liz Ann Sonders, CIO Schwab (March 27, 2024)

The past few years have seen market swings wreak havoc with investor sentiment. But despite the volatility, markets have made new all-time highs. With high volatility the norm, investors should take advantage of swings to rebalance their portfolios. Or as Liz Ann Sonders describes it, “add low, trim high.”

Full transcript below.


About this week’s guest:

Liz Ann Sonders is Chief Investment Strategist and Managing Director at Schwab, where she helps clients invest $8.5 Trillion in assets.

For more info, see:

Personal Bio

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Barry Ritholtz: Since the October  2022 lows, markets have had a great run recovering all of their losses and then some, but valuations are higher and the market seems to be narrowing. How should long term investors respond to these conditions? I’m Barry Ritholtz, and on today’s edition of At the Money, we’re going to discuss what you should be doing with your portfolio.

To help us unpack all of this and what it means for your money, let’s bring in Liz Ann Saunders. She is Chief Investment Strategist and sits on the Investment Policy Committee at Schwab, the investment giant that has over 8. 5 trillion on its platform.

Liz, let’s start with the basics. How should long term investors be thinking about their equities here?

Liz Ann Sonders: Well, you know, Barry, shame on anybody that answers that question with any kind of precision around percent exposure. And that’s not just on the equity side of things, but broader asset allocation. I could have, a little birdie from the future land on my shoulder and tell me with 99% precision what equities are going to do over the next whatever period of time, what bonds are going to do, even what maybe real estate was going to do.

But if I were sitting across from two investors, one was a 25-year old investor that inherited 10 million from the grandparents. They don’t need the money; they don’t need to live on the income. They go skydiving on the weekend. They’re big risk takers. They’re not going to freak out at the, the first 10 or 15 percent drop in their portfolio.

And the other investor is 75 years old; has a nest egg that they built over an extended period of time. They need to live on the income generated from that nest egg and they can’t afford to lose any of the principal. One essentially perfectly high conviction view of what the markets are going to do. What I would tell those two investors is entirely different. So it depends on the individual investor.

Barry Ritholtz: So that raises an obvious question. Um, you work with not only a lot of individual investors, but a lot of RIAs and, and advisors. How important is it having a personal financial plan to your long term financial well-being?

Liz Ann Sonders: Essential. Absolutely essential. You can’t start this process of investing by winging it. It’s got to be based on a long term plan and it’s, it’s driven by the obvious things like time horizon, but too often people automatically connect time horizon to risk tolerance. I’ve got a long time horizon, therefore I can take more risk in my portfolio, vice versa.

But we often learn the hard way, investors learn the hard way, that there can sometimes be a very wide chasm between your financial risk tolerance, what you might put on paper, sit down with an advisor, establish that plan, time horizon coming into play, and your emotional risk tolerance.

I’ve known investors that should essentially on paper have a long-term time horizon but panic button gets hit because of a short term, uh, period of volatility or drop in the portfolio, then that’s an example of learning the hard way that your emotional risk tolerance may not be as high as your, uh, financial risk tolerance.

Barry Ritholtz: Let’s talk about that a bit. Everybody seems to focus on, let’s pick this stock or this sector or this asset class. Really, is there anything more important to long term outcomes than investor behavior?

Liz Ann Sonders: Absolutely. Too many investors think it’s, it’s what we know or somebody else knows or you know that matters, meaning about the future, what is the market going to do? That doesn’t matter because that’s impossible to know. What matters is what we do. along the way.

I enjoy these conversations because we get to talk about what actually matters. And it’s the disciplines that arguably are maybe a little bit more boring to talk about when you’re doing, you know, financial media interview. The bombast is what sells more, but it’s asset allocation, strategic, and at times tactical. It is diversification across and within asset classes. And then the most beautiful discipline of all is periodic rebalancing, and it forces investors to do what we know we’re supposed to, which is a version of buy low, sell high, which is add low, trim high.

Barry Ritholtz: Add low, trim high, add low, trim high.

Liz Ann Sonders: I almost, the reason why I have that sort of nuance change to that is buy low, sell high almost infers market timing, get in, get out. And I always say that neither get in nor get out is an investing strategy. All that is, is gambling on two moments in time.

Barry Ritholtz: And you have to get them both dead right.

Liz Ann Sonders: And I don’t know any investor that has become a successful investor that’s done it with all or nothing get in and get out investing. It is always a disciplined process over time. It should never be about any moment in time.

Barry Ritholtz: So we’ve been in the cycle where the Fed started raising rates and markets down. Um, became much more volatile. Now everybody’s expecting rates to go down. What do you say to clients who are hanging on every utterance of Jerome Powell and trying to adapt their portfolio in anticipation what the Fed does?

Liz Ann Sonders: Well,  to use the word adapt, expectations have adapted to the reality of the data that has come in, not to mention the pushback that Powell and others have shared. And even before the hotter than expected CPI report and hotter than expected jobs report, that the combination of those, brought the Fed to the point of Powell at the press conference at the, you know, January FOMC meeting saying it’s not going to be March.

But even in advance of that, we felt the market had gotten over its skis with not only a March 2024 start but as many as six rate cuts this year. The data just did not. Uh, support that. You know, that, that old adage, Barry, I’m sure you know it, of, of the Fed typically takes the escalator up and the elevator down.

They clearly took the elevator up this time. I think their inclination is to take the escalator down.

Barry Ritholtz: You deal with a lot of different types of clients. When people approach you and say, I’m concerned about this news flow, about Ukraine, about Gaza, about the presidential election, about the Fed. Do any of those things matter to a portfolio over the long term, or is this just short-term noise? How do you advise those folks?

Liz Ann Sonders: Well, things like geopolitics tend to have a short-term impact. They can be a volatility driver. But unless they turn into something truly protracted that works its way through You know, commodity price channels like oil or food on a consistent basis, they tend to be short-lived impacts.

The same thing with elections and outcomes of elections. You tend to get some volatility,  things that can happen within the market at the sector level. But for the most part, you’ve got to be really disciplined around that strategic asset allocation and try to kind of keep the noise out of the picture.

The market is almost always extremely sentiment-driven. I think probably the, the best descriptor of a full market cycle came from the late great Sir John Templeton around “Bull markets are born in despair and they grow in skepticism, mature in optimism, die in euphoria. I think that’s such a, a perfect descriptor of a full market cycle.

And what’s maybe perfect about it is there’s not a single word in that that has anything to do with the stuff we focus on on a day to day basis. Earnings and valuation and economic data reports, it’s all about psychology.

Barry Ritholtz: In order to stay on the right side of psychology, given how relentless the news flow is. We’re constantly getting economic reports. They’re constantly Fed people out speaking. We’re just wrapping up earnings season. How should investors contextualize that fire hose of information? And what should it mean to their buy or sell decisions?

Liz Ann Sonders: Tto the extent some of this stuff does drive volatility, use that volatility to your advantage. A lot of rebalancing strategies are calendar based. And it’s forced to be calendar based in the, in a situation like mutual funds that do their rebalancing at the last week of every quarter. But for many individual investors, they’re not constrained by those rules. And one of the shifts in a more volatile environment where you’ve got such a firehose of news and data coming at you and that can cause short term volatility is to consider portfolio-based rebalancing as opposed to calendar based rebalancing. Let your portfolio tell you when it is time to add low and trim high.

Barry Ritholtz: So in other words, it’s not like every September 1st, it’s, hey, if the markets are down 20, 25 percent – Good time to rebalance, you’re adding low and you’re trimming high.

Liz Ann Sonders: And that’s within asset classes too, whether it’s, uh, something that happens at the sector level or, you know, Magnificent Seven type action. And, and that’s just a better way to stay in gear as opposed to trying to absorb all this information and trying to trade around it to the benefit of your performance. That, that’s, that’s a fool’s errand.

Barry Ritholtz: What do we do in a year like 2022, which admittedly was a 40-year run since the last time both stocks and bonds were down double digits?

How do you rebalance or is that just one of those years where, hey, it’s literally a 40 year flood and you just got to ride it out?

Liz Ann Sonders: I mean, it’s obviously been a tough couple of years in terms of the relationship between stocks and bonds. And we do think that we are in the midst of a secular shift. For much of the Great Moderation era, which essentially represents the period from the mid to late 90s up until the early years of the the pandemic, you had a positive correlation between bond yields and stock prices because that was a disinflationary era for the most part. So as an example, when yields were going up in that era, it was usually not because inflation was picking up. It was because growth was improving.

Stronger growth without commensurate higher inflation, that’s nirvana for equities.

But if you go back to the 30 years prior to the great moderation, I’ve been calling it the temperamental era from the mid-sixties to the mid-nineties, that relationship. was almost the entire period, the complete opposite of that. You had that inverse relationship

Because bond yields, as an example, when they were moving up in that era, it was often because inflation was sort of rearing its ugly head again. Now that’s a very different backdrop, but it’s not without opportunity. In some cases it may be a benefit by taking more of an active approach both on the equity side of things and on the fixed income side of things.

The other thing to remember is that there’s the price component on the bond side of things, but there’s also the fact that you, you, you are going to get your yield and your principal if you hold to maturity.

So for many individual investors, much like we say, be really careful about trying to trade short term on the equity side of things, the same thing can apply on the the fixed income side of things.

But it’s, it’s a different backdrop than what a lot of people are used to.

Barry Ritholtz: So to sum up, there’s a lot of noise. There’s news, there’s Fed pronouncements, there’s earnings, there’s economic data. All of which creates volatility, and that volatility creates an opportunity to rebalance advantageously. When markets are down and you’re off of your original allocation, if your 70 30 has become a 60 40 because stocks have sold off, that’s the opportunity to trim a little bit on the bond side, add a little bit on the equity side, and now you’re back to your  allocation.

Same thing when markets run up a lot, and your 70/30 becomes an 80/20.  It doesn’t just have to be a calendar based allocation. You could be opportunistic based on what markets provide.

I’m Barry Ritholtz. You’re listening to Bloomberg’s At The Money.




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