Jay Vivian, former managing director of the IBM Retirement Funds, shares the research on portfolio rebalancing and how investor psychology works against portfolio rebalancing in a timely fashion. Read more on how human emotions can ultimately damage long-term investment performance.
Rebalancing is an interesting psychological study in human nature. What you do is, you want to sell the investments that have done well, and you want to buy the ones that have done badly. And that’s not typically the way our brains work.
If something’s done really well, you feel good about it. And the last thing you want to do is sell it. When something’s done badly and you’re reading articles about it and your friends are talking about it, especially if you hold it and you’ve been kind of not telling them that you actually held that stock that has gone down — it’s not easy to reverse that. So there’s a psychological pressure to not rebalance, if you will. But if you think about the, certainly the research, what goes up will come down. And what goes down will often come up.
So sometimes it’s actually better to sell the things that have done well, to trim some of your gains there and put them in some of the stuff that’s gone down with the hope that it’ll come back. This turns out to be supported by a lot of academic research, so you have to fight that urge.
So a lot of good investing has to do with fighting what your brain tells you. Your brain is not a good investor. Your brain’s good at finding patterns. Unfortunately it’s good at finding patterns that aren’t there. Your brain is good at liking stuff that’s done well. Sometimes the stuff that’s done well is not the stuff you should hold on to. Your brain is good at not going down that path. Maybe that’s because your brain evolved when you were in the forest and the last two times you went down that forest there was a tiger down that path.
But, you know, if you sell the stock that has done really badly, maybe that’s not the right thing to do. It was the right thing to do not to go down that path where the tiger lives. Maybe not the right thing to do to sell the stock that went down, when there’s a good chance it’ll come back up.