Buy low, sell high. Simple. But not easy. For most individual investors (and basically all professional investors), timing the market and picking entry and exit points is a fool's errand. But there is a proven if unexciting method of mechanically buying low and selling high over the long haul: systematic rebalancing.
Boring. But remarkably important to overcoming the innate psychological barriers that tend to impair our judgment in making investment decisions. The recent bull market amidst the COVID-19 pandemic has served up another reminder.
Legendary investor Sir John Templeton counseled investing at the point of "maximum pessimism". Warren Buffet, the "Oracle of Omaha", propounds: "Be fearful when others are greedy and greedy when others are fearful." But it is the rare bird that could commit capital staring into the abyss of a 30% plunge as COVID gripped the country, or rake off excess profits in Bitcoin after a 50% spike. At least, it is difficult to do so consistently and purposefully. That is where the discipline of regular rebalancing helps do it for us.
The process begins with establishing a target mix of investments in stocks and bonds that best suits your personal tradeoff of risk against desired returns over a long horizon. We focus on these simple classes for simplicity, but your mix may include real estate, collectibles, gold or other assets classes and the principle applies equally. On the day you implement your plan, the world is in its orbit and your investments are in perfect balance. As time passes, some assets perform better than others. Markets rally, stocks rise or fall, the economy booms and busts, time marches on. Before long, your hypothetical 60% stock target has grown to 70% (or dropped to 50%). This is where emotion and instinct can be our enemy.
A simple rebalancing scheme restores order to your portfolio by shifting some money out of assets that have run ahead and redeploying more cash into laggards. Sell high, buy low.
The same principle applies in a more granular way among sub-assets classes like US versus foreign stocks, large cap versus small cap, and growth versus value. Shifting cash out of overachievers into relative underperformers imposes a discipline that works to improve long-term returns and to minimize overall risk.
Emerging Markets represent one of the highest potential but also most volatile asset classes on average. In 2017, EM soared 38%, by far the best performing asset of the year. A systematic rebalancing would have taken profits from Emerging Markets and shifted into fixed income, the worst performing class. In 2018, EM dropped from first to last with a 14% loss, while fixed income was the best performer. Our gut might have said "let it ride", but a mechanical rebalancing would have sold high and bought low.
The lesson applies equally to investment styles as well. From 12/31/19 to 8/31/20, growth stocks outpaced value stocks by an incredible 36 percentage points as tech and other "stay at home" plays dominated. However, since 8/31/20 through May 2021, a sharp reversal has taken place during which value stocks beat growth by 18 percentage points. Few investors predicted the sudden reversion, but a methodical rebalancing would have capitalized on the shift.
Thankfully, the process of rebalancing need not be complex. There are two approaches to the task: regular periodic rebalancing (say twice a year) or setting tolerance bands of a certain percentage for each asset class (perhaps plus or minus 5%). The latter requires more continuous monitoring, but the good news is that it doesn't matter much which method you choose. Empirical studies can generally not discern a "best" methodology, but consistently demonstrate that any rebalancing scheme produces superior returns and reduced risk over time versus no action at all.
If you employ an advisor, this is part of the service. If you do it yourself, there are lots of tools available at your brokerage firm's website, and many brokers now offer the service for little or no cost with so-called "Robo Advisor" autopilot services. Most decent 401(K) plans also include options for routine rebalancing.
You don't need a crystal ball. Just a plan and the occasional course correction to remain disciplined and stay on the plan.
Christopher A. Hopkins is a chartered financial analyst in Chattanooga.