Portfolio Rebalancing: Discretion can be Dangerous
One of the advantages of typical asset allocation where investors maintain fixed percentages of stocks and bonds is that portfolio rebalancing makes us automatically sell high and buy low. However, this advantage only exists if you actually do the rebalancing.
Unfortunately, many investors seek reasons to avoid rebalancing at the very time it would give the greatest advantage. Catherine Gordon on the Vanguard blog discussed rebalancing recently. I don’t want to pick on her too much, but her remarks include the following:
“This is a good time to take a hard look at that allocation and ask questions such as, ‘Was I really too aggressive for what I was trying to do?’ or ‘Was I truly diversified?’”
It may not be her intention, but when stocks are down, many investors asking themselves these questions would decide that they had been too aggressive and should not rebalance from bonds to stocks.
This past March would have been a fantastic time to have sold bonds to buy stocks to maintain a chosen asset allocation. However, too many investors, driven by fear, failed to act.
When failing to act, one investor might just stick his head in the sand and another might say “I’ve decided that my model portfolio was too aggressive.” The latter investor may sound more intelligent, but a truism in investing is that if two people take the same actions, they will get the same results no matter who is smarter.
Many commentators debate how often one should rebalance, and whether it should be done on a time schedule or triggered when percentages deviate by a certain amount. The truth is that these considerations matter little compared to whether the investor chooses a rule and sticks to it.
Sadly, too many investors use their discretion to avoid rebalancing during times when it would do the most good.
Unfortunately, many investors seek reasons to avoid rebalancing at the very time it would give the greatest advantage. Catherine Gordon on the Vanguard blog discussed rebalancing recently. I don’t want to pick on her too much, but her remarks include the following:
“This is a good time to take a hard look at that allocation and ask questions such as, ‘Was I really too aggressive for what I was trying to do?’ or ‘Was I truly diversified?’”
It may not be her intention, but when stocks are down, many investors asking themselves these questions would decide that they had been too aggressive and should not rebalance from bonds to stocks.
This past March would have been a fantastic time to have sold bonds to buy stocks to maintain a chosen asset allocation. However, too many investors, driven by fear, failed to act.
When failing to act, one investor might just stick his head in the sand and another might say “I’ve decided that my model portfolio was too aggressive.” The latter investor may sound more intelligent, but a truism in investing is that if two people take the same actions, they will get the same results no matter who is smarter.
Many commentators debate how often one should rebalance, and whether it should be done on a time schedule or triggered when percentages deviate by a certain amount. The truth is that these considerations matter little compared to whether the investor chooses a rule and sticks to it.
Sadly, too many investors use their discretion to avoid rebalancing during times when it would do the most good.
For some people it is unfortunately the case that after a decline they should re-evaluate their plan and see that they still need to move money out of stocks because they can't afford any more losses. However that would be prevented by adjusting the plan earlier, so there is some value to this advice. If people just use it as an excuse to justify emotional decisions it's their loss.
ReplyDeleteSilicon Prairie: If investors' need to spend money is so imminent that they can't afford more paper losses, then they shouldn't have been in risky investments in the first place. However, this applies to few investors. In most cases when investors say that they can't afford any more losses, what is really going on is that they've lost their cool and want off the roller-coaster. Too bad for them that the roller-coaster was on the way back up.
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