My clients hear and see my mantra all the time: “Stay Diversified, Stay Your Course!” I am constantly urging the people I advise to remember the importance of maintaining a proper mix of different types of assets and careful, ongoing adjustment of that mix to keep them on the path we agreed on when they began investing. There are two important principles at work: diversification and rebalancing. Diversification is what sets you on your course, and rebalancing is how you stay there.
Remember that the assets in your portfolio are not static: they change in price, both up and down. These changes, if left unattended, will eventually create imbalances in your holdings. When you set up your strategy, you decided on a certain mix of different types of assets, depending on your level of risk tolerance and your goals. It is important that you maintain your portfolio within those same parameters, and the only way to do it is to rebalance.
When we rebalance a portfolio, we usually reduce the percentages of assets that have increased in price, because this very growth—a good thing—has caused these assets to take up more space in the portfolio than it was designed for—a bad thing. We may sell a portion of these “expanded” assets in order to bring the mix back in line, or we may use new money from outside the portfolio to purchase more of the assets that are presently undervalued. Either way, we bring the asset mix of the portfolio back into the originally-agreed proportions.
Especially in an environment of market volatility, like the one we’ve seen during October 2018, rebalancing is important. When the market heads downward, as it did dramatically on October 11 and 24, stock assets become less expensive. It may be appropriate, as a part of rebalancing, to purchase stocks in the portfolio, since that portion may be falling below the desired allocation level. On the other hand, when bond prices are falling, it may be time to buy fixed-income assets, again, to maintain the proper balance. Over time, a discipline of buying assets when they are lower in price and selling them when they are higher may generate higher returns. But the main reason for rebalancing is to maintain the overall risk characteristics of the portfolio within the agreed-upon boundaries.
We’ve all heard the saying, “Plan your work, then work your plan.” The idea is that once you decide how to accomplish something, you need to stick with your method and give it a chance to work. Similarly, in investing, we place tremendous value on carefully formulating an individualized plan, then maintaining that plan: through market upswings and downturns, year in and year out. Over time, a disciplined approach that relies on research rather than emotion may be expected to provide superior results. Rebalancing provides the “mid-course adjustment” that helps the plan stay in place.
Stay Diversified, Stay Your Course!