Friday, August 19, 2011

Rebalance your portfolio annually

Over the past few weeks I’ve had numerous friends express concern about the economy and financial markets and have asked for my thoughts.  My thoughts follow…

The way I look at it, everyone has to make a choice between two possibilities and plan accordingly:

(1) Anarchy will reign - stockpile guns, ammo, barbwire around your farm and bomb shelter etc.
(2) We'll get through this like we have for 200 years - rebalance your portfolio and buy stocks when they are down.

I can respect folks who choose either of these options, but anything in between is pointless.
Being 100% cash won't work in either scenario. If the financial system collapses, they won't be able to get their cash out of whatever bank it is in.  Even if they could get it, cash will be worthless during true anarchy. Not many folks would sell their last loaf of bread for any amount of gold either.  

In 2008 we truly were standing at the edge of anarchy - that was scary.
That was the scariest time in our economic history... Oh wait, maybe World War I was scarier,
and WWII. Oh yeah, 9/11 when stock market was closed for a week - now that was scary!  Don’t forget the turmoil caused by the Korean and Vietnam wars.  Then there were the race riots in the 60-70s. Can you imagine riots? I can't but it was going on when we were kids. Assassination of JFK, Reagan shot, Nixon's Watergate, Clinton's Lewinskigate. How about nuclear missiles a couple hundred miles off the shores of Florida? Now that must have been really scary.

I'm forgetting a dozen catastrophes I'm sure. Yet, the stock market averaged
about +10% annualized return throughout all this. To be sure, the stock market is never up in a straight line.
What is beautiful is the crookedness of the returns. Each and every instance I listed
above was a BUYING opportunity.  

Folks that are 100% liquid now may well look like geniuses.
Greece could default and implode the entire European Union. Moody's could agree with S&P and downgrade the US credit rating a meaningless notch. Politicians might shut down the federal government, again (yeah, that's right, it's happened before and in our lifetime too).

But, even if those "liquid" folks are right and the market dives another -20%, they'll never have the foresight or fortitude to buy back in at the bottom when everything looks it's worst. Thus, they can be right ONCE and cost themselves a ton of money when the market snaps back. The folks that are liquid now,
are likely liquid because they sold out before the bottom in the market in March 2009.  They likely watched the Dow fall from 14,000 to 8,000 and finally decided to sell all their stock funds. They realized they were geniuses as the Dow continued it's descent to 6,500. But, in the end they would have been better off doing nothing as the Dow is now back up to 11,000 (even after the recent decline) and MUCH higher than where they likely sold. Better yet, instead if selling at 8,000 they would have done well to BUY at 8,000 even while that was not the bottom and the market fell further.

That is another great point; one does not have to pick the exact bottom in the stock market to make a lot of money. The folks that bought stocks at Dow 8000 surely felt more pain as they watched it continue to fall to 6500. But, with the Dow currently at 11,000 they certainly are happier now than the folks that sold at 8000.

We should almost be grateful for each of these "opportunities" that the "sky is falling" alarmists provide us.
Embrace the volatility. The easiest way to do that? Own a mixture of stock and bond index funds and....

Buy monthly with your paycheck and rebalance annually on your birthday.

Buy and rebalance, buy and rebalance - year after year after year. 
Over the course of a lifetime, you will have bought low and sold high over and over and over again.
Rebalancing is easy to do in “normal” years. In fact, it’s almost unnecessary most of the time.
When rebalancing is crucial is in times like these – when you have to buy when everyone else is selling.
But, history has shown time and time again, the time to buy is when everyone else is selling.

Rebalance annually and mechanically, don't "think" about it.
Turn off CNBC. Be oblivious. Be happy. Be wealthy.


P.S. You can find more information in one of my 4 books on Amazon at the link below.

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