Traders use many measures to figure out when to buy or sell a given investment. Fundamentals, price-to-earnings ratios, even crazy things like Superbowl matchups.
Yet you don’t have to know the inner workings of a company or predict the tectonic shifts ahead in the entire stock market. All you have to do is rebalance.
Rebalancing is easy, so easy that many people leave it until the end of the year, an afterthought at best. Yet it is the most important move you can make with your retirement investments.
Here are five reasons why it’s important to rebalance now:
1. Asset allocations are out of whack
The stock market had a great run in 2013, up nearly 30% on the S&P 500. The Barclays Aggregate Bond Index was down 2%.
It takes a lot of courage to sell your winners, at the moment stock holdings, and use that cash to buy bonds. Yet practicing rebalancing doesn’t require one to make an “all in” bet on the direction of either investment. It really only asks you to sell a portion of the winning hand and to reinvest in assets that are comparatively cheap. Right now, that’s bonds.
2. Portfolios should be more than two asset classes
Many retirement investors are trained to accept the simplicity of the classic 60/40 split of stocks and bonds. Research and experience have shown, however, that a fully developed portfolio owns at least some foreign stocks and bonds, commodities and real estate.
Emerging market stocks, commodities and real estate in 2013 have underperformed compared to U.S. stocks and foreign large-company stocks. A retirement investor can regain a balanced portfolio by redistributing to these investments as well.
3. Picking up that extra 1.5%
Why rebalance at all? Because it’s free money. Burton Malkiel, a member of the Investment Committee of my firm, Rebalance, studied portfolio returns over the past 15 years and concluded that the simple act of rebalancing offered investors an extra 1.5% over the straight stock market return.
Compounded, that 1.5% makes a huge difference. An investment of $10,000 over 20 years growing at 7% becomes $38,697. That same investment earning 8.5% comes in at $51,120.
4. Discipline trumps emotions
The really key feature of rebalancing is that it requires you “do the right thing” when it matters most. Research has shown that the typical failing we have as investors is understanding accurately when take advantage of an otherwise obvious gain.
We chase winners higher, only to be disappointed over time. Or we sell losers at the bottom, locking in losses. Rebalancing removes this stumbling block by taking emotion out of the equation. It’s time to rebalance, so do so.
5. Buy low, sell high
Need more convincing? Consider the most basic of investment goals: buy low and sell high. Makes sense, right? Rebalancing, whether you do it annually, quarterly or all through the year, institutionalizes the practice of selling high and then buying back in low.
That’s how you get Malkiel’s extra 1.5%, by routinely taking a portion of your gains off the table and using that to buy whatever asset classes are currently “on sale.”
Rebalancing is not hard to do. What’s hard is overcoming that gut feeling that you “know” what will happen next in the markets. Ignore that feeling and rebalance. You’ll feel better about your investments every time you do it, and decades of academic research show that, over time, you’ll actually do better as well.