Last year I wrote that rebalancing your investments is something most investors can forget. The reason is that rebalancing is simply selling high and buying low with no guarantee that whatever you’re buying low would perform well going forward.
Rebalancing is selling your winners and buying more of your losers.
The way rebalancing works is if you own two mutual funds and your allocation is 50-50 and one fund makes money this year and the other does not by the definition of rebalancing you simply take a portion of the profits from one and invest it in the one that did not do so well. (It’s like giving one hundred dollars to your dead-beat brother-in-law and hoping he’ll find a job otherwise he’ll be back on your stoop and you’ll be shelling out another hundred and then another.)
Along comes Burton G. Maikiel, professor of economics at Princeton, while updating his book, ‘A Random Walk Down Wall Street’, writes for the WSJ that Buy and Hold is still a winner, rebalancing is something every investor should do and index funds outperform two-thirds of all active managed mutual funds. He goes on to say that his studies have shown that rebalancing into an allocated portfolio has increased returns over time by 1%.
As someone with a solid third grade education I am just dumb enough to take umbrage with the good professor. The problem, as I see it, is knowing which index fund to buy, what allocation to rebalance into and not holding either an index or mutual fund that languishes in investor Purgatory for an extended period of time. These bits Professor Maikiel specifically does not share with us but provides clues in his book so individual investors can establish their own personal investment plan.
It makes little difference in the wisdom of Burton that the best portfolio managers such as Danoff at Contra Fund, Bill Miller at Legg Mason or even Warren Buffett ignore indexing, eschew buy and hold forever (except for the odd stock here and there), and have never stood on their hind legs and voted for rebalancing. They are also some of the best active managers in the business and while certain indexes have languished over the past decade this trio, among others, has made money for its shareholders only because they are active money managers.
The single biggest sin investors make is holding onto losers while selling winners in the mistaken belief that losers may one day become winners.
In the beginning of this decade I was hosting a radio show and a listener called and said he was taking a beating on his S&P 500 index fund and his wife suggested he sell it and move on but he felt it was a good investment for the next decade and he agreed to leave the decision to me. I told him I agreed with his wife that there were better opportunities and he hung up telling me we were both nuts. He wasn’t looking for advice he was seeking affirmation. It is little solace that I was right and he was wrong.
Investors have to be wary of those investment disciples who preach a belief in a system as if it were the only way to manage money. There are some very successful investors who own portfolios that have stood the test of time that have only one or two funds, have never rebalanced and trusted their active portfolio manager to modify their individual holdings.
Last by not leastest; (if Palin can make up words so can you and I) researching the good Professor Burton a bit more I came across some scribbling and ramblings where he pointed out, albeit ala pianissimo, that he agrees with what I’ve always believed because; some markets are evidentially inefficient, exhibiting signs of a non-random walk and while he is partial to index funds he does think it is viable to actively manage ‘around the edges’ of such a portfolio, as financial markets are not totally efficient. In other words, indexing is good but not the only way to build a portfolio.
In a nutshell there is theory from them Ivory Towers, dear reader, and then there is common sense. Then, of course, there is the selling of books.
Questions call Paul @ 877 783 7080 or write him at pstanley@westminsterfinancial.com. Share this blog with someone who cares about their money.
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