Why We Update Portfolio Allocations and ETFs Each Year

Some of the best approaches for long-term investment success are to invest in a diversified portfolio based on your goals, keep costs low and stay the course through the inevitable market ups and downs. But how do you know how much of your portfolio should be invested in stocks compared with bonds and other asset classes? And what funds should you use to represent each asset class?

The answer to these questions requires having insight into the expected risk and return of each asset class, as well as how their price movement interacts with other asset classes. Schwab Intelligent Portfolios^® uses this insight to design diversified portfolios of exchange-traded funds (ETFs) across the risk spectrum. These return forecasts are updated annually. And, as part of our ongoing portfolio management, we review and potentially update portfolio allocations and ETFs each year. These updates could result in an increase in trades or shifts in your goal status.

Charles Schwab Investment Management, Inc. (CSIM) is the portfolio manager for Schwab Intelligent Portfolios and develops long-term Capital Markets Expectations (CMEs) for each asset class in your portfolio. CMEs estimate the average expected return and volatility for each asset class over the next 10 years and are reviewed and updated annually to reflect evolving economic and market conditions over time such as long-term growth, inflation expectations and corporate earnings outlooks. While it's challenging to accurately predict short-term investment returns, estimating long-term averages is less difficult and necessary for informed asset allocation models and portfolio construction.

Schwab Intelligent Portfolios uses these long-term average forecasts as inputs to design diversified portfolios with various combinations of asset classes depending on where you are on the risk spectrum. Your portfolio is monitored daily and rebalanced as needed to make sure that its targeted allocation and intended level of risk stay consistent with your goals.

With yearly CME updates, your portfolio might see modest changes in the quantity of various asset classes it holds from year to year. Keep in mind these are generally small adjustments and not intended to dramatically alter the allocation of your portfolio or to completely shift in or out of various asset classes. The trades you see in your account as a result of these allocation adjustments are simply to reflect the updated long-term outlook and are not for short-term tactical market timing purposes.

The CME updates can also affect your goal status or–for clients with a Schwab Intelligent Portfolios Premium^® financial plan or Schwab Intelligent Income^® feature–your probability of success. For example:

• An increase in long-term expected returns for asset classes in your portfolio would tend to positively impact your goal status or raise your probability of success, if everything else remained static.
• A decrease in expected returns could shift your goal status to "at risk" or "off target" or reduce your probability of success, if everything else remained static.

If you find your goal is "at risk" or "off target" or in the "below confidence" zone, here are some options to help you get back on track.

• Consider increasing your recurring contributions, if possible. A small additional contribution has the potential to put you back on track depending on your investment timeframe.
• Or if you're currently taking withdrawals, you might think about reducing your withdrawal amount temporarily, if possible. Postponing some discretionary expenses can allow you to shift that money to cover your essential expenses in the short-term.

Keep in mind that if your portfolio rises in value and performs better than projected, your goal could move into "on target" from "at risk." Some fluctuation in your goal status is to be expected as markets move up and down over time, but it's important to try to stay "on target" towards reaching your goals as much as possible, following the guidelines or steps above. Revisiting your goals, risk tolerance, and time horizon annually and whenever you have a change in your financial situation is recommended as well.

The exchange-traded funds (ETFs) used in Schwab Intelligent Portfolios are also evaluated annually to make sure they continue to meet our selection criteria for accurate representation of the asset class, liquidity and low costs. As with asset allocation updates, this does not mean that you should expect to see big changes in the ETFs your portfolio holds from year to year.

ETF changes can occur for several reasons, but one of the main drivers has been lower ETF expense ratios. Over time, ETF providers have tended to reduce their ETF expense ratios, which has given us an opportunity to replace a few ETFs each year with others in the same asset class but with lower expense ratios, helping to further lower the cost of investing for you.

The result of our annual asset allocation and ETF review is to help make sure your portfolio continues to reflect the long-term investment landscape to keep it aligned with your risk profile. While informed asset allocation and portfolio construction can be a daunting task for individual investors, Schwab Intelligent Portfolios provides access to the benefits of professional management to do this complex work for you as part of helping you work toward achieving your goals.