5. Investment Rebalancing
“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t expect to buy what is popular and do well.”-Warren Buffett
Simply buy low and sell high without thinking
The market is a pendulum that forever swings between unsustainable optimism, which makes stocks too expensive, and unjustified pessimism, which makes them too cheap. Asset Allocation wouldn’t help much if you don’t rebalance your asset to keep in line with your diversification.
Let's say you have 2 stocks (50/50 split): Skyrocket Corp. and Slowly but Surely Inc. Skyrocket is all over the news everybody is bragging about it, it has been exceeding expectations and every analyst is recommending a buy. Slowly but Surely is out of the spotlight doing his own thing and just meeting expectations and analysts don’t have anything to say, good or bad, about this boring stock.
Now your Skyrocket went up and it currently represents 75% of your holdings. You are richer than you were. At this point you should ask: has the price risen too high and should I think of selling? Or worse yet should you now give weight to the bull market atmosphere, become infected with enthusiasm, the overconfidence and the greed of the general public and buy more? Generally speaking a stock price is related to the company’s earnings multiple, meaning as their price goes up you’re paying 10X or 20X their profits per share making it more risky or less risky as the price goes down.
Rebalancing is the process of realigning the weightings of your portfolio asset allocation (back to 50/50 split) by taking temptation out of the equation. It is basically selling off or taking the gains of your best performing assets (Skyrocket Corp) and purchasing or averaging down on your steady assets (Slowly but Surely Inc). Simply put, periodic rebalancing is a way to force you to buy low and sell high.
Rebalancing is an unemotional action, based on a schedule set either by how far off-plan a portfolio gets, or by regular calendar intervals. We believe the key is to rebalance on a predictable, patient schedule, not so often that you will drive yourself crazy, and not so seldom that your targets will get out of whack. The beauty of periodic rebalancing is that it forces you to base your investment decision in a simple and objective manner.
Remember: With a diversified portfolio, if you start investing early and take advantage of dollar cost averaging through regular investment contributions; and if you rebalance your investments yearly and don’t over react to the market when it is going up or down, you will be farther ahead of any active manager over time.
Sell in May and go away
This strategy is based on the historical underperformance of stocks in the six-month period commencing in May and ending in October, compared to the six-month period from November to April. According to the Stock Trader's Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the summer months, compared with an average gain of 7.5% during the November-April period.
This theory is not a perfect science. This phenomenon might be due to people selling their stocks in May in preparation for kids getting out of school and summer vacations coming up and when everybody is back from the holidays in September trade volumes come back to normal.
Although the exact reasons for this seasonal trading pattern are not known, lower trading volumes due to the summer vacation months and increased investment flows during the winter months are cited as contributory reasons for the discrepancy in performance during the May-October and November-April periods, respectively. Please keep in mind we’re not trying to time the market but we believe this is a good basis to setup a periodic rebalancing schedule.
Remember: Numerous studies have shown that investors who set up a desired asset allocation and focus on maintaining it at a rock-bottom cost tend to outperform those who swing for the fences and incur high expenses and taxes as a result.
How to get there from here (Investment Rebalancing):
The final piece of the puzzle is to review your investment on a fixed schedule no more than every six months and no longer than every 2 years. The “Sell in May and go away” is one of the theories out there as a suggestion to set up your rebalancing agenda.
___ The ultimate step to achieve your financial success is to setup a reminder for yourself, whichever way that may be, to rebalance your portfolio around the 15th of May and the 15th of October.
Now is time to put all those pieces together, get into action and take care of your future.
How to get there from here (Investment Principles).