Ignore Rebalancing

One of my gripes is the push that some financial firms have to rebalance their client's investment portfolio. I got an e-mail from a client who asked if I rebalanced client's investments and that got me started. Rebalancing is nothing more than selling your winners and holding your losers.

How does it work? Let's say you have a portfolio with one-third bonds, one-third in domestic equities and one-third in foriegn. Not everything is going to go up and down in the exact same percentage. The theory is to maximize the possibility of reducing risk and increasing the opportunities for gain that an investor removes excess profits from the winning portions and replaces the losing sectors until everything is in the same exact percentage as originally designed.

Lets keep it simple and say you have 50% in bonds and 50% in the S&P 500 Index. At the end of the year the bond portfolio has made money and the equity side has lost. The theory is that equities may have their turn next so get the allocation back to where it was so that an investor can maximize their return. What really has happened is that over the past 10-years the bond portfolio has consistently outperformed the equity side and the investor ended up feeding the losing end with more money that could have increased their profits.

If left alone the bond portfolio would have had more money each year and would have enjoyed more profits. Over a longer period of time the equities would have returned the favor but why reduce the chance of making money in a winning sector and plowing them into a loser?

Rebalancing is doing exactly what smart profitable investors don't do and almost every structured asset allocation plan implements. Rebalancing sells winners and puts more money into losers. Wall Street in its attempt to add bells and whistles to client's portfolios (and higher fees) have simply increased the chances of clients losing more money whether they invested in variable annuities or designed asset allocation plans by mutual funds or retirement plan sponsors.

Forget rebalancing. Buy good quality mutual funds, ETFs and ride your winners and cut your losers. You'll be surpirsed how much better you'll find yourself doing.