Rebalancing is a Buy-Low / Sell-High Strategy
Since the beginning of the October to the low point of October growth (equity) markets around the world have fallen roughly 10%. The safety portfolio, such as a GIC or short-term bond ETF like Vanguard Canada’s VSB, is flat. So, the growth portion of a portfolio has fallen drastically over the month and the safety portion has remained flat.
Rebalancing is the process to get the distribution of savings back to the target distribution and should be done periodically and specifically when markets move drastically.
To illustrate the process let’s imaging that $100,000 was placed into investments at the beginning of the month with a 60% growth / 40% safety asset allocation. The growth portion was 40% U.S., 30% Canada, and 30% the rest of the world. The $60,000 growth portfolio is worth $54,000 after the 10% decline. The safety portion remained stable at $40,000. The portfolio is now worth $94,000 with $40,000 in safety. Safety accounts for 42.5% of the portfolio after the equity market decline. To rebalance to a 60% / 40% asset allocation, $2,400 needs to be moved from safety to growth.
This is difficult to do. And, I am not referring to the mechanics. Why is this difficult to do? $100,000 was invested less than a month ago and is worth $94,000 now. This is a substantial drop in a short time period. No investor would be happy with the growth portion of their portfolio. Yet, I am suggesting that you move money out of the asset class that didn’t fall and invest it in the asset class that fell almost 10% in less than a month. That doesn’t sound like great advice. The news headlines are all screaming bad news. Pundits are predicting that growth markets could fall 30% (pick a number) more. No one knows. You will never read in a newspaper or hear on TV that the decline is over and the right time to buy is now.
One thing, though, is certain. The growth portfolio is 10% less expensive than it was a month ago. This is important. Buying growth makes more sense now than at the beginning of the month. We are buying at a lower price. No one grows net worth by buying high, selling low. Note that you are moving 2.6% of your portfolio, a small portion, from growth to safety. After the trade the portfolio will hold $56,400 in growth and $37,600 in safety. This trade can be done many times. Should growth markets continue to fall, the rebalance trade should continue.
Buy low, sell high sounds easy but involves making an uncomfortable trade when growth is getting pummeled. Courage is required. The main justification for the rebalance trade is that your asset allocation was chosen with purpose. Market movement has drifted your portfolio asset allocation away from its target allocation. Rebalancing gets it back.