The world of finance bustles with extravagant investment ideas, while simple, effective ideas are often ignored.
For instance, if there is a universal investment ideal, it is probably this: Buy low and sell high. There exists an unassuming process for doing just that - at least historically and when applied consistently over time - called "rebalancing," but it is often overlooked for more exciting ideas.
Rebalancing: How It Works
When establishing a portfolio with a client, we target assets in particular percentages personalized to their specific intentions. As time passes, the investments stray from their original target “weights” or allocations. Rebalancing is the simple act of shifting those allocations back where they belong.
To illustrate, imagine your portfolio was intended to be half stocks and half bonds, 50/50. When stocks go up, you end up with more stocks relative to bonds. Or, of course, the reverse can happen, too. Either way, you’re no longer at your intended 50/50 mix. Whenever you stray too far, we consider selling some of one half and using the proceeds to buy more of the half that has become underrepresented until you’re back at your desired mix.
In the example below, a 60/40 portfolio allocation is targeted.
Sounds simple and easy, right?
Not only did we keep your portfolio on track as intended, but given the market's history of markets rising over time, when applied consistently over time, you tended to buy low and sell high.
Better still, "what to do next" wasn't a matter of fancy guesswork or emotional whims. The feat was accomplished according to a pre-stated, customized plan.
“The beauty of periodic rebalancing is that it forces you to base your investing decisions on a simple, objective standard.”
Rebalancing in Real Life: A Closer Look
As simple as the concept is, real-life rebalancing takes a few more steps.
First, we build a balance between stocks versus bonds, reflecting your need to take on market risk in exchange for expected returns.
Then, we typically divide these assets among stock and bond subsets, again according to your unique financial circumstances. For example, we will likely assign percentages of a subset of stocks (small- vs. large-company and value vs. growth firms), and further divide these among geographic locals (international, U.S., and emerging markets). These relatively precise allocations target the "right" amount of expected market premium while offsetting the market risks involved.
Finally, costs must be considered. If trading were free, we could rebalance your portfolio every day with absolute precision. In reality, trading incurs transaction fees as well as potential tax liabilities. To help us achieve a reasonable middle ground, we have guidelines for when and how to cost-effectively rebalance.
“Investing isn’t about beating others at their game. It’s about controlling yourself at your own game.”
Simple, But Not Easy
In short, rebalancing regularly is integral to helping you succeed as an investor. But like any power tool, it should be used with care and understanding.
Rebalancing can be hard to do in real-time. The logic of buying low and selling high is intuitive. But when it’s time to act, your gut reaction might make it easier said than done. (Do you remember what investors were worrying about last year? How about several years ago, or several decades ago? Look back with us here.) This is where we can help prevent interference with an objective nudge.
“The sillier the market’s behavior, the greater the opportunity."
Rebalancing when times are bad:
Bad times in the market can represent good times for rebalancing.
But that means you must sell some of your assets that have been doing well and buy the unpopular ones.
The Great Recession of 2007–2009 is the quintessential example. To rebalance then, you had to sell some of your safe-harbor holdings and buy stocks, even as popular opinion was screaming that stocks were dead. Of course, history has shown otherwise; those who did rebalance were well-positioned to capture available returns during the subsequent recovery. But at the time, it represented a huge leap of faith in the academic evidence indicating that our capital markets were expected to prevail.
Rebalancing During A Down (Bear) Market
Rebalancing when times are good:
An exuberant market can be another rebalancing opportunity – and another challenge, as you must sell some of your high-flyers (selling high) and rebalance into the lonesome losers (buying low). At the time, this feels counterintuitive. But those who rode the 1990s dot-com wave through its crest can understand why it’s a good idea to periodically shift some of your captured returns to safer grounds.
REBALANCING DURING AN UP (BULL) MARKET
The Rebalancing Take-Home
Rebalancing gives you a clear, evidence-based process for staying on course toward your personal goals through rocky markets. It creates a reliable path to buying low and selling high along the way.
“The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.”
Are your finances on track to where you want to go? When was the last time you checked?
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All quotes attributed to: Benjamin Graham (May 9, 1894 – September 21, 1976)
Benjamin Graham was a British-born American economist, professor and investor. He is widely known as the "father of value investing", and wrote two of the founding texts in neoclassical investing: Security Analysis (1934) with David Dodd, and The Intelligent Investor (1949). His investment philosophy stressed investor psychology, minimal debt, buy-and-hold investing, fundamental analysis, concentrated diversification, buying within the margin of safety, activist investing, and contrarian mindsets. Benjamin Graham. (2023, August 4). In Wikipedia. https://en.wikipedia.org/wiki/Benjamin_Graham