Quick question:
What does a good investor have in common with a good tightrope walker?
They both remember to rebalance!
HA!
I’m here all week folks. Don’t forget to tip your wait staff!
Forgetting to rebalance is just as dreadful for an investor as it is for a circus performer. Let’s talk about why.
First, let’s dispense with a definition. My definition of rebalancing is this:
Rebalancing is the act of periodically putting one’s portfolio back to one’s previously well thought-out asset allocation based on one’s unique risk tolerance, time frame, goals, and objectives.
Fun, huh? Disecting each part of that definition results in the following:
1 ) …act of… – this means that rebalancing is an action. You. Must. Do. It. (or at least cause it to be done through automatic programming). Rebalancing is something that must be done, by you.
2) …periodically…this doesn’t mean whenever you feel like it or whenever you remember. It means you need to select that time and mark it in your calendar. We prefer annually, but semi-annually is OK, too. Quarterly…eh…you’re probably wasting time. Any more frequently than quarterly and you’re doing market timing by a different name.
3) …putting…portfolio back… This next part is relatively easy. You’re putting it back – the way it was. No thought required here. Just like I tell my kids. Put your toys back the way they were. In the places they were before you played with them.
4) …previously well thought-out… During your rebalancing activities, you do not need to redesign your model. You’ve already done that. Previously. And it was well though-out.
5) …asset allocation based on unique… We could spend hours here, but here’s where you should’ve spent some serious thinking time around your risk and goals. Rebalancing is only rebalancing if it’s back to an asset allocation.
What can happen if one doesn’t rebalance?
That’s easy – anecdotally, consider the late 90s or late 2007. A big run up in one area of the market (say the Large Cap stocks of the 90s) could mean they’re overvalued. What happens when something’s overvalued? It eventually becomes undervalued! Rebalancing can help to sell winners at a gain and buy more shares of positions that are undervalued.
One of the “tricks” professionals have up their sleeves is rebalancing. It is a automatic process designed to take the thinking and emotion out of investing and allow investors to capture profits and reposition those dollars where they can buy the most shares of undervalued investments. Use rebalancing to your favor!
PS: The US stock market is up HUGE this year. Is it time you rebalanced???
Photo: quinn.anya
This is huge. My husband and I finally realized we could set our 401ks to automatically rebalance and over the last two years we’ve seen significant improvements in our investments. I love that the Standard does it every quarter and we don’t have to think about it. It’s pretty great.
I didn’t really think about it as rebalancing, but that’s just what we did a month ago. We do tend to buy and sit on stocks and often our balancing act each year is just taking a look at our portfolio and deciding where our next investments should be to keep things balanced. We have a professional investment advisor, so we aren’t stumbling around blind.
I believe the same advice holds true in real estate investment as it does in stock portfolios. Over the past couple of years, many investors have turned away from buy and hold properties and jumped into the fix and flip mentality. Well the days of dirt cheap real estate are almost finished – perhaps it is time to return back to what worked well in the past.