In investing, it’s okay to be wrong.
Just be sure it’s on the small stuff and not on big questions like how much money to have in the stock market. Let’s look at a way of putting up a fence in your portfolio to keep stocks right where you want them. The process is called rebalancing and it should be undertaken once every six to 12 months, depending on how old you are.
We’ll assume here that you’ve taken the elementary steps of finding a correct mix of stocks and bonds for your age, and identified your investing goals and risk tolerance. Rebalancing means looking at your investments to see how far they have wandered from your ideal mix of assets. A good year for the stock markets might give you too much exposure to stocks, whereas a bad year for the markets might give you too much of a skew to bonds.
Rebalancing basically means selling some of your winners and buying more of your losers. It sounds counterintuitive, but in fact what you’re doing is following the core investing principle of buying low and selling high.
Why not let your winners run? We’ve seen in recent years how having too much of a portfolio in stocks can hurt you. If you have a 50:50 ideal mix of stocks and bonds, letting your stock weighting climb to 60 per cent could have painful consequences. When interest rates eventually start to rise, we will see how too heavy a skew to bonds can also work against you (bonds and bond funds fall in price as rates rise)
If you’re five years away from retirement or are retired, you should check every six months to see if a rebalancing is necessary. You have to play defence at this stage of your investing life, and rebalancing is an effective way to do that. Think of rebalancing as the means by which you control the stock market’s wilder tendencies. You probably need some stocks in your portfolio, but you want strict limits on them.
Younger investors face far less urgency to rebalance because they have so much more time to fix the problems that arise from a bad mix of stocks and bonds. And yet, rebalancing once per year is still worthwhile because it can lead to steadier, more successful investing over the years. You’re going to make mistakes in your lifetime of investing. Rebalancing is one way to minimize them.