One of the most commonly quoted pieces of investment advice (or cliché) is you want to buy low and sell high. It’s as simplistic, as it’s unhelpful.
Despite the obviousness of the advice, there’s only one proven way to do this consistently: through a tactic called rebalancing. It’s an important wrinkle to remember as the summer doldrums hit.
Despite the flurry of activity on the last day of July, as the Federal Reserve hinted at September interest rate cuts, the summer results in fewer trades and, commonly, poorer performance. While there’s no hard-and-fast rule to these things, historically speaking August has the second-worst performance, as a month of the year, and very low trading levels, due to vacations and other summer activities.
This could indicate that whatever gains you may have seen in your portfolio over the course of 2024, could slow. It also entices some to try and time the market with a sell-off. The stats on that also prove doubtful that you will do it well.
Instead, ignore the chatter from the markets, and practice a tried-and-true method to capturing gains.
Why Rebalancing Works
When you begin investing, you have a set amount going to different assets, depending on how much risk you want to embrace and the style of investing you choose (active versus passive tactics). But as the market moves, certain assets perform well, while others drop in value. In a properly diversified portfolio, this will happen constantly.
But after time, the assets that perform better start to outweigh the underperforming investments, leading to a portfolio that no longer reflects your original allocation.
To rebalance, you must sell some of the assets that have performed well – in essence selling high – to purchase more of the shares that performed poorly. The poorly performing assets, you’re essentially buying at discounted prices. This, in essence, achieves the buy-low, sell-high framework.
Keeping your portfolio diversified and balanced requires this rebalancing once or twice a year.
Numbers Support the Practice
In 2020, Morningstar analyzed the rebalancing benefits over a 26 year period dating back to 1994. Despite the poor performance of the market at the time due to COVID-19, rebalancing once, annually, showed a similar rate of performance to a buy-and-hold strategy (without rebalancing).
But the buy-and-hold strategy will have significantly higher risk, since it will have a much higher equity exposure (compared to the 60% stock-40% bond portfolio that the researchers were analyzing). For instance, in the evaluation over 20 years from 1994 to 2014, the worst performing metric was buy-and-hold without rebalancing, since many of the investors would have been overweight equities heading into the tech downturn of 2000, resulting in significant losses that were slow to regrow.
Ironically, the best performing strategy was rebalancing daily, which most investors will avoid due the laborious effort involved.
Pick a Date and Stick to It
The best way to incorporate rebalancing into your investments is simply pick a date in the year, mark it on the calendar, and then rebalance on that date every year.
This allows you to rebalance without having to time the market.
Why don’t we want to time the market? Investors are notoriously bad at doing so.
More than 90% of professional investors underperform a basic index fund over the course of 20 years, according to S&P Dow Jones Indices. Meanwhile, a Charles Schwab study found that investors who had bad market timing while investing $2,000 every year for 20 years saw a total of $121,171 at the end of the time period. It vastly underperformed the investor who immediately invested the money each year, which saw a final total of $135,471.
While, of course, perfectly timing the market performed best in the Schwab study, finding a perfect market timer is far rarer than a booming August market.
Instead, pick a date and stick to it. You can choose a time, like your birthday, or specific points in the year – say the summer doldrums – to get your portfolio back in line.
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