As December draws to a close, it is time to catch your breath and assess the damage. With the exception of the few who were sitting in cash and CD’s, no one escaped 2008 undamaged. Even gold, once considered the haven for tough times, has sunk 15% from its peak in ’08. There was similar sentiment for real estate, whose fate is still not fully known.
As I surveyed various individuals throughout the year, I have found that their responses to the market volatility have run the gamut. On one end of the spectrum you have the person who won’t open their statements or look up their account online for fear that seeing the result will make it come true. At the other end you have the financial junkie who hits ‘refresh’ every 10 minutes to track the twists and turns of the market while simultaneously listening to CNBC and receiving market alerts on their cell phone. No matter which camp you find yourself in, you are likely still asking, “What should I do next?”
One consideration is rebalancing. Of course, this presumes that your portfolio was in ‘balance’ to begin with, based on your investment goals, risk tolerance, and time horizon. Presuming it was, why should you rebalance? Let’s assume that you were invested 60% in the broad stock market and 40% in bonds or a similar income investment. With the stock market decline for the year hovering around -40%, while high quality bonds were relatively flat, your balanced 60/40 portfolio is now 47% in stocks and 53% bonds. For some, you may look at this as relief, having less exposed to the volatile stock market. For others, you may recognize that for someone with a long time horizon, you are now out of balance.
Rebalancing is essentially putting into practice ‘buying low, selling high’. In this particular case, because bonds have held up relatively well, they are the equivalent of ‘high’. Therefore, to get back into balance, you are essentially taking 13% of the bonds and purchasing stocks. One may ask, do we recommend the same philosophy when the stock market goes up? Absolutely! If you were in a 60/40 mix and the stock market rose 40%, your allocation would move to a 68/32, and we feel it is equally important to ‘sell the winners, buy the losers’.
What are the benefits of rebalancing?
- It takes the emotion out of investing, countering our natural impulse to try to time the market.
- It keeps us focused on the big picture, ensuring that we are investing based on our goals, risk tolerance, and time horizon.
- We are purchasing more shares at a lower cost in the area that has declined.
- It positions us for the other side of the market cycle, whether it is a stock market rally or a stock market decline.
What should you do? First, determine whether your portfolio is in fact balanced to your investment profile. If not, obtain objective assistance toward this end. Second, if you haven’t rebalanced in the past six months, given the extreme swings in the investment markets, you may want to consider doing so. Third, set a range that triggers your next rebalance. For example, if your target is 50% stocks/50% bonds, how far from this mix until you should rebalance back to 50/50? Establishing this discipline will allow for a more balanced approach to investing for your future.