Many financial professionals tout portfolio rebalancing as the key to your financial success. But is it really that important? Or is it just another smoke screen Wall Street uses to convince you they know more than you do? Let’s take a look.
What Is Portfolio Rebalancing?
This financial maneuver is meant to automate your process of buying cheap and selling dear. The best way to explain is by way of example. Let’s say you have $100,000 and you go for an initial 50/50 split between equity and fixed income. As a result you sink $50,000 into each asset class.
After a year the equity portion of your portfolio grows to be worth $60,000 but the bonds drop to $40,000. If you believe in rebalancing you would then sell $10,000 of the equity portion of your portfolio and buy $10,000 more in bonds. This returns you to the 50/50 split you originally had. And it also forces you to sell high and buy low. That’s because you are selling high (the appreciated stocks) and buying cheap (the bonds that fell in value). It doesn’t help you diversify your portfolio but it is meant to reduce your risk.
It’s simple and probably sounds pretty good to you. But is it a smart move? It depends on who you ask.
Some advisors are rebalancing freaks. These people point to attractive investment track records over long periods of time it. But other managers with equally impressive results have entirely different opinions on the matter.
They argue that it just doesn’t make sense to sell assets that are performing well – and that’s exactly what portfolio rebalancing does. It’s like taking the golden egg and hard boiling it. By the same argument, they feel that there is no logic to buying as asset that is declining in value.
That’s like trying to catch a falling knife and it’s equally as dangerous.
In the example above, the rebalancing critics ask you to consider how rebalancing hurts you if equities continue to rise and bonds continue to decline. And if you think about it, they have a good point too.
And it gets more complicated. Other managers *(me included) define portfolio rebalancing differently. They suggest you take the exact opposite path. Buy more of the best performing positions and sell the weaker ones.
Bottom line? Rebalancing has its pros and cons. It can work for you or against you. The best way for you to decide how to rebalance your assets is to first make a decision about investment strategy and stick with it. No investment approach is perfect.
Do you rebalance your portfolio? How? What do you like about it? What do you dislike about it?