31. A Rebalancing Act

It's funny to read the analysts these days: they're bathing in the market panic, with useless advice such as "be active, stay with the winners, the coming days will tell us where the market is going", etc.

The demystified investor can sleep soundly, since she doesn't really care. Stocks going down only mean it will be cheaper to buy them. As long as you don't need the money now, and as long as you don't believe that the entire economy is going up in smoke, you should not be worried. And you should do nothing with your portfolio - unless it's your rebalancing day.

My rebalancing anniversary is December 25th. This is how it works. I set up a fixed ratio of my allocation goal (you can see it in my going naked post.) Let's assume, for simplicity, that your goal is 60% stocks and 40% bonds, invested in an S&P broad index fund and a well-diversified bond fund, respectively.

In a few months, when your rebalancing anniversary arrives, there are a few possible scenarios:

The market recovered to pre-crash numbers. You're still at 60-40. Nothing to do - hooray!

Stocks haven't recovered. Your balance changed from 60-40 to 40-60. You sell a third of your bond fund and buy stocks to return the balance to 60-40. The rebalancing forced you to sell high (bonds) and buy low (stocks). Hooray!

Or, stocks have recovered and passed their pre-crash levels, bringing your balance to 70-30. Everything looks rosy, the economy is looking great, but your rebalancing policy will force you to sell 1/7 of your stocks and buy bonds, returning to the 60-40 balance. Here, the rebalancing forced you to sell high and reduce your risk.

As long as the long-term prospects are positive, this method will ensure that you don't panic and sell after a crash, only to see the stocks bouncing back. It will also ensure that you're not tempted to over expose yourself to the stock market, thinking it can never go down. And, as a side benefit, it minimizes the number of transactions you do, commissions you pay, and of course taxes.

Of course, as I said in my last post, if you have a time machine or tomorrow's newspaper you can do much better. Unfortunately, I don't have them, and I'll have to stick with the second best option: the one listed above.

It's the third big market crash in 10 years. We recovered from the .com bust, the housing market bubble, the huge losses of the banks in 2008, the shock of 9/11, wars and other disasters. I don't see any reason to believe this time is different. The worst that can happen is a prolonged recovery or another mini-recession. So ignore the news, don't look at your numbers, don't try to predict the future, and, for god's sake, don't listen to Cramer or the other clowns. Enjoy the ride!