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Financial advisors and other media will tell you that year-end is the time to consider rebalancing your portfolio. You know, that time where you sell some of your winners to buy some of your underperformers and restore your original target asset allocation.

It’s been a process that’s become more difficult to justify in recent years.

Ever since the Fed dropped interest rates to 0% in the mid-2010s, bond yields and total returns have been virtually non-existent. Over the past 10 years, the total return on the iShares Core U.S. Aggregate Bond ETF (AGG) has been 16%, a scant 1% average annual return. That compares to a 249% total return for the SPDR S&P 500 ETF (SPY) and a 438% return for the Invesco QQQ ETF (QQQ).

How about a few other asset classes that would generally be considered part of a diversified portfolio? International developed markets stocks have returned just 66%. Emerging markets? A grand total of 32%. Gold has been doing much better over the past year, but even the precious metal’s total return over the past decade is only 111%.

Clearly, diversifying away from U.S. equities hasn’t paid off for a long time. But does that mean rebalancing is no longer a useful exercise?

In my opinion, the answer is yes, but it really depends on what your personal goals are.

If you’re a long-term investor who just wants to keep your risk exposures within a tight range and aren’t necessarily looking to swing for the fences, rebalancing makes a lot of sense. In general, just the idea of “buy low, sell high” that’s inherent in rebalancing is something that market pundits are always preaching. Most investors are performance chasers who often end up doing just the opposite and it hurts their long-term returns. Regular rebalancing helps solve that.

Momentum investors will likely want to let their winners run. In the current situation, they probably wouldn’t want to rebalance and instead keep riding U.S. large-caps until they stop rising. There’s a bit more downside risk with potentially hanging on for too long, but as we’ve seen over the past decade, there are certainly situations where it works well.

Before moving forward any further, let’s take a look at each of these asset classes over the past decade.

From a pure return standpoint, SPY and QQQ are the clear winners. Even though volatility levels are generally higher, they’ve clearly been superior to bonds, gold and foreign stocks.

Outside of U.S. stocks, the asset class that has done the best both in terms of absolute and risk-adjusted returns is gold. A lot of that return has come in just the past year, but it’s not just those numbers that demonstrate its potential use in a broader portfolio. Gold has traditionally maintained almost no consistent correlation to stocks over the long-term. That makes it one of the best portfolio risk diversifiers available. If you’re truly looking to reduce overall portfolio volatility, gold almost has to be considered.

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International stock returns have been miserable for years, but that doesn’t mean there isn’t a case to still be made for them. If you look over decades of history, U.S. and international stocks have traded leadership in roughly 10-year cycles. The S&P 500 has led consistently since 2010. The 2000s mostly belonged to international. The 1990s were led by U.S. stocks. International generally outperformed during the 1970s and 1980s.

This stretch of S&P 500 is obviously getting long in the tooth. If you’re a long-term investor, there’s a reasonable chance that international experiences an extended stretch of leadership at some point in the not-so-distant future.

Bonds, in my opinion, present a much better risk/reward profile today than they have in the recent past. When rates were near 0%, there was very little upside for fixed income, both in terms of income generated or share price growth potential. Now that yields are still in the 4-5% range, they’re a viable alternative again. Income seekers don’t need to go out on a limb into junk bonds or even equities for yield. If a market correction were to occur, there’s plenty of share price upside to be had in Treasuries during a flight to safety shift.

The point is that there is still a setup where diversification and rebalancing still make a lot of sense. Don’t just look at the past decade and assume that it will be this way forever. Bonds will lead again at some point. International will lead again at some point. The idea of diversification shouldn’t be dismissed out of hand.

Asset correlations, not just overall volatility levels, may be the key determinant in deciding what to rebalance into.

As mentioned above, gold has done the best job historically of being a risk diversifier. I know it gets a reputation as an inflation or downside hedge. History has proven, however, that there’s consistent track record of gold’s ability to accomplish that. The only time where gold has worked as an inflation hedge in the past is when the inflation rate has gotten above 5%. And even then it hasn’t consistently worked. Gold is much better as a pure risk hedge regardless of time frame.

International stocks still have a relatively high correlation to U.S. stocks, although emerging markets tend to have a lower correlation. Bonds don’t really have the negative correlation to stocks that many believe they do, although it often trends that way during stock market pullbacks. 2022 was an all-time outlier when the S&P 500 and long-term Treasuries fell more than 20% at the same time. Treasuries usually work well as a downside hedge during sharper drawdowns and they likely will again in the future.

Final Thoughts

This is a classic case of “past performance is not an indicator of future results”. Yes, rebalancing would have very likely hurt total returns when compared to a buy-and-hold investment in the S&P 500, but it won’t always be that way.

If risk mitigation is your goal, rebalancing still make sense. It does, however, take discipline to take some chips off the table when an investment is rising in value and buying one that’s declined. Historically, this has worked well and it forces some positive behaviors if executed correctly.

From a risk reduction standpoint, gold is likely going to work best. From a standpoint of reducing portfolio downside, fixed income, Treasuries in particular, are probably still the best choice despite recent struggles. A modest allocation to international stocks still makes sense if you have a long time horizon and wish to maintain a portfolio of mostly equities.

Higher Yielding ETF Alternatives

Even though the Fed has begun cutting interest rates and 5% yields are no longer a slam dunk, there are still plenty of good options in the 4-6% range that don’t overexpose you to risk. It may no longer as simply as buying a Treasury bill and forgetting about it, but 5% yields are still quite attainable.

Note: Check out my 5% Target Yield and 6% Target Yield model portfolios for some ideas.

Here are some high yield, low risk ETFs that I’m favoring right now.

• iShares Floating Rate Bond ETF (FLOT) - This fund still offers a 5.2% yield currently and invests solely in corporate floaters. The floating rate structure ensures that duration is close to zero and has little interest rate sensitivity. It consists entirely of investment-grade bonds with only 4% of the portfolio in the BBB-rated category. That means you’re getting an unusually high quality portfolio with that yield.

• Janus Henderson AAA CLO ETF (JAAA) - I’ve overweighted this ETF specifically in my 6% Target Yield portfolio due to the fact that you can get 100 basis points of extra yield for minimal additional risk. The 6.3% yield provides a nice alternative to Treasury bills and the AAA-rated securities it holds suggests little credit quality risk. CLOs aren’t the same as bonds though. Many fall into the leveraged loan category and may be more illiquid than traditional bonds. That creates the potential for some additional downside risk should conditions turn and that’s why it comes with the higher yield.

• American Century Multi-Sector Floating Income ETF (FUSI) - You could probably say this fund falls somewhere between FLOT and JAAA. It also invests almost exclusively in investment-grade floating rate securities, but its portfolio is a mix of CLOs, MBS and ABS securities (and a small allocation to Treasuries for liquidity). Because of this volatility will be a little higher, but not even as high as the iShares 1-3 Year Treasury Bond ETF (SHY).

I also tried to talk myself into the iShares 0-5 Year High Yield Corporate Bond ETF (SHYG) as an ETF to consider, but I just couldn’t get there. The short-term focus makes it a better alternative to broader or longer-term junk bond funds and the 7% yield is nice. But I just don’t like the risk/reward profile of junk bonds right now. Credit spreads are historically low, which means there’s very little yield premium being offered for the level of risk being taken. If anything turns south here, those yields are likely to blow out and result in some significant downside for this group. Wait for a better entry point.