(photo credit: INGIMAGE / ASAP)
I am always begging my children to think. If something doesn’t make sense, question it. If a teacher makes a broad sweeping generality that can’t be backed up, raise your hand and challenge. In fact, the only thing that can’t be questioned is something said by their parents! Unfortunately we live in a society where people too often don’t think. Maybe because of the technological revolution and that so much of our learning and entertainment is passive; it’s as if society has turned off their brains. This seems to apply in most disciplines. But when it comes to investing, too many investors do the opposite: They overthink.
One of the trickiest aspects to long-term investing is when it comes to rebalancing your portfolio. I often see investors who have a hard time effectively rebalancing because they think they can outsmart the market.
Why rebalance? The point of rebalancing is to realign the weightings of one’s portfolio of assets. Rebalancing involves periodically buying or selling assets in your portfolio to maintain your original desired level of asset allocation.
In time periods when stock returns are much higher, many investors can find themselves with portfolios much more heavily tilted toward stocks then when they started out. Conversely, if bond returns outpace stock returns by enough of a margin, your portfolio could become more bond heavy, or conservative. The point is that by just sitting and doing nothing, your portfolio can change into something that you don’t want it to be.
Keep in mind that there are many studies that point to the benefit for investors in reducing their portfolios’ long-term volatility by scaling back on asset classes that have stellar gains and adding to the losing ones.Buy low/sell high
Rebalancing also has another benefit: It forces you to do something investors all say they want to do but rarely have the discipline to pull off – sell high and buy low. Rebalancing is not just between stocks and bonds. It can be done within the equity portion of a portfolio as well. As the S&P 500 continues to trade close to all-time highs, it’s not easy for investors to downsize their US holdings and buy more international stocks. After all, international stocks have seriously underperformed their US counterparts for five to six years.
Christine Benz of Morningstar hits the nail on the head when she writes: “Rebalancing can be psychologically difficult. It seems counterintuitive to trim the best-performing securities in a portfolio; one might logically assume that they’ve got the right stuff and will keep on winning. Moreover, the winners in a portfolio often appear to have a macroeconomic tailwind.
Just think of US stocks right now. The US economy has been steadily improving and shows no imminent signs of slowing down, so trimming them might look like a sucker’s bet.”
Investors should not forget that nothing goes up in a straight line forever, and they should start thinking about investing in markets that may provide more value. It is also important to remember that when looking at year-by-year returns of key market indices, it is very rare that one specific asset (e.g., US large-cap) will keep providing the highest returns; usually asset-class returns are cyclical.
What I wrote in my book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing four years ago is still the case: “The OECD reports that over the next 20 years the middle class in the North America is set to drop by both numbers of people and as a percent of the global middle class. The situation in Europe is much worse; its share of global middle class is expected to drop from 36% in 2009 to just 14% in 2030. Contrast that to Asia and the rest of the world where you see explosive growth in the middle class, and you can clearly see that most of us will be living part of our retirement years during a major economic leadership change.”
As I mentioned above, international and especially Asian and Emerging markets are cheap relative to the US, and with the longer-term economic trends firmly at play, it is a potentially good time to invest. Investors need to do their own research to make sure this type of investment fits their risk profile.
Don’t be afraid. For those needing a portfolio rebalance, it may make sense to lower US equity exposure and add international stocks as dictated by your asset allocation.
The information contained in this article reflects the opinion of the author and not necessarily the opinion of Portfolio Resources Group, Inc., or its affiliates.[email protected] Aaron Katsman is a licensed financial professional in Israel and the United States who helps people with US investment accounts. He is the author of the book Retirement GPS: How to Navigate Your Way to A Secure Financial Future with Global Investing.