It Sounds Counterintuitive, Yet Rebalancing Could Be Your Single Greatest Investing Move

It Sounds Counterintuitive, Yet Rebalancing Could Be Your Single Greatest Investing Move

Looking to hit that home run with your investments? Of course, who wouldn’t be? Then you must be prepared to be counterintuitive and take actions that go against the grain of conventional wisdom. I’d even go so far as to say that you must be willing to take the occasional odd action.

Here’s why. One of the fundamental things that every long-term investor must do religiously – based on the occurrence of certain predetermined triggers – is what is referred to in financial planning as rebalancing. In basic terms, rebalancing is the process of realigning your investment portfolio back to its original and/or predefined target setup.

For example, let’s say that prior to investing, Mary determined that the appropriate level of risk for her timeframe and risk tolerance is 40 percent equities/stocks and 60 percent fixed income/bonds.

However, because real-world markets often tend to change, and rather unexpectedly, this 40/60 mix is bound to get out of sync. Let’s assume that Mary’s equities did really well, but her bonds went south. As a result, stocks now make up 60 percent of Mary’s portfolio and fixed income represent 40 percent. So her portfolio has changed from her original 40/60 to 60/40.

Although things may look great for Mary because her account balance may have increased, here’s the catch. The current portfolio mix contains much more risk than she set out to take. Stocks now represent 60 percent and bonds only 40 percent - a whopping 20 percent higher than her actual stock tolerance.

Mary needs to rebalance her portfolio back to her target 40/60. To do that, she must sell 20 percent of her stocks and buy 20 percent more bonds. Yes, I know. That sound like the wrong move. Stocks are up bonds are down, so why sink her money into what is presently down?

Remember what I said earlier? Rebalancing is completely counterintuitive to conventional investing wisdom. You’re basically selling the winners and buying losers. Wow, that's hard to accept. But it is precisely the right thing for Mary to do. You never want to plan based on what you perceive might happen in the future - because no one knows. Neither is it done based on what you feel. Rebalancing must be entirely based on what has already happened.

Now back to Mary’s portfolio. Think about it this way. She’s selling stocks at the time that they are higher in value and, in turn, buying bonds that have dropped in value. Bonds are practically on sale, which if you really think about it is precisely the right time to buy, isn’t it? What about the stocks she’s selling at a higher value? That’s great, too, isn't it?

When it comes to money and investing, conventional wisdom most of the time has nothing to do with wisdom. Please find yourself an experienced, honest financial professional who can help you build a suitable plan and, most importantly, help you do the difficult but prudent things that are good for your future.

All the best.

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