How to Buy Low and Sell High Regularly
Everyone wants to know the secret - how can I buy low and sell high regularly? There are two paths to achieve this goal. The first is to become a student of the markets, studying charts and graphs, watching financial news around the clock, and devouring every piece of information available. Active investment managers follow this model and are successful at beating the market only about half the time. (The Case For Index Investing, Vanguard Research, April 2014).
The second option follows a much simpler model: pick an asset allocation that meets your needs and rebalance periodically. Asset allocation is the process of how to divide your investments into stocks, bonds, and cash. Rebalancing is a process to periodically take gains from your winners and add to your losers (assuming the fundamentals are still sound). It's that simple - buy low, sell high, repeat.
There are several different ways to rebalance a portfolio, each with its own merits. The most important action is to actually rebalance - which method is best is an ongoing debate that will likely never be resolved. The methods can be used alone or together.
The portfolio is rebalanced to the target allocation based on a set schedule - quarterly, semi-annually, or annually. Most 401(k) plans offer automatic rebalancing on a calendar basis. Is yours set up?
The portfolio is rebalanced if the allocation differs from the target by a pre-determined threshold, often 3% or 5%. For example, a portfolio with a target of 60% stocks and 40% bonds and a 3% threshold would be rebalanced when the stock allocation varied above 63% or below 57%. Threshold rebalancing helps keep the portfolio on track without excessive trading.
A combination of calendar and threshold rebalancing, momentum rebalancing looks at market conditions to decide when to rebalance. For example, if the stock market is performing well and the economy shows no sign of danger, momentum rebalancing would allow the stock portion to exceed the target allocation as long as the market continues upward.
This method introduces risk as it requires a decision on when to rebalance. It can be useful when combined with a flexible threshold. For example, a manager could set a 5% rebalance threshold but allow it to fluctuate by up to 10% before a mandatory rebalancing.
During the accumulation phase (e.g. saving for retirement), simply use your periodic contributions to buy whichever sectors of your portfolio are below the target allocation.
During the withdrawal phase (e.g. in retirement), simply sell from the sectors of the portfolio that are above the target allocation.
Which method does Freedom Wealth Partners follow to manage portfolios for clients? All of the above! Many factors are involved in the decision of how and when to rebalance: are you adding or withdrawing funds or planning any changes in the next 6 to 12 months, are there any transaction costs involved, are there any tax consequences involved, where are we in the market cycle, and finally, what is your risk tolerance?
We are always available to discuss how rebalancing impacts your portfolio. If you have any questions, concerns, or newly found money to invest, please don't hesitate to call or email.