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Putting Discipline & Risk Management on Autopilot...

Rebalancing: Putting Discipline & Risk Management on Autopilot

I wish I had a nickel for every time I saw the market swing and then heard investors and commentators wonder what they should do next. "I just don't know what I should be doing," is a common admission from investors and "sell the losers and buy the winners" is advice provided by commentators on a seemingly endless loop.

It's understandable that investors wonder what to do next. Every magazine cover, stock analyst, financial commentator, and web site seems to give different and contradictory advice about where to invest, when to invest, and how much to allocate to which market.

Typical reaction from media commentators is to encourage investor to sell the losers and buy the winning asset categories. This piece of advice might sound like prudent investing. After all, who wants to continue to own something that just went down in value? The problem with this line of thinking is that investors wind up selling low and buying high, the exact opposite of the golden rule of investing. Quick refresher; the Golden Rule of Investing is to:

Buy Low and Sell High!

This rule is so easy to understand and yet so difficult to actually implement. We often liken this to the common goal of losing weight. To lose weight the rules are simple, eat less and move more, yet the rules are much more difficult in practice.

Before I go on to explain how to put the Golden Rule of Investing on autopilot, let's look at one more reason why "sell the losers, buy the winners" advice may not be in your best interest. When investors and commentators see the markets swing and begin to consider their next move, they are limited to only two options. First, they can emotionally react to what has already occurred with the belief that the future will be similar to what they had just experienced; we call this trading in hindsight or chasing markets. The second option is to trade based on their forecast, or best guess, about what the future holds; we call this gambling and speculating since no one can consistantly and reliably predict the future.

So how can you put the golden rule of investing on autopilot? It's a process called rebalancing. Rebalancing is the systematic process of selling high when one or more asset classes are relatively high and buying into asset classes that are relatively low. Of course when selling high during rebalancing we are only selling a small portion of any one asset class in order to trim the percentage of that holding back to your original target percentage.   This process is one of the greatest risk management tools you have at your disposal.

For example, take a portfolio invested 50% in fixed income (bonds) and 50% in stocks. Let's assume during the quarter there is a drop in the stock market and a gain in the bond market, which means you now have less stocks as a percentage of the portfolio and more fixed income. Let's say the new allocation is 60% fixed income and 40% stocks. The portfolio is out of balance and holds more fixed income than what we started with.

This is the point where fear typically sets in and investors are encouraged to sell the remaining stocks to avoid further declines in the stock market and to buy into bonds where the returns came from in the recent quarter. The hope being the market direction will continue indefinitely. The problem is the markets move in random and unpredictable patterns. If there were predictable patterns in the markets then market timing would be an easy game and Wall Street would be able to successfully capture the gains and avoid the losses. As we saw with Bear Stearns and Lehman Brothers, even the best can't predict the future direction of markets.

So what would the prudent investor do at this point?

Rebalance!

We would sell off a portion of the bond portfolio (which just increased and is above our target allocation) and we would buy into the stock market (which just decreased and is now below our target allocation). This would bring the portfolio back to the 50/50 balance we started with. This process assures us that we won't get greedy and hold onto winning asset classes longer than we should or panic and sell after market declines.  Repeat this process quarterly over the life of the portfolio and you have set the discipline to buy low and sell high on autopilot.

Rebalancing is crucial and is extremely difficult both

emotionally and intellectually to do it on your own!

If you'd like to know more about how rebalancing and how you can put discipline and risk managment on autopilot, visit our web site and do one of three things to get started:

1. Request introductory materials to learn more about our firm & how we can help you become a more confident investor.

2. RSVP for our upcoming Investor Only workshop entitled "The Enigmas of Investing."

3. Call our office (805) 648-5300 and speak to Tiffany to schedule you free 45 minute coaching converstation to begin examining your greatest opportunities and threats in how you are curently investing.

Note: Diversification does not guarantee a portfolio against loss. The example portfolio was for illustrative purposes only and does not represent any actual portfolio or recommendation.

Important Message for Every Investor...

Inevitably downward market volatility causes stress, anxiety and in some cases panic. My message today for investors is not to lose sight of your long-term goals and time horizon. Short-term volatility is to be expected, and doesn't mean that your portfolio isn't working. While it goes against all of our human instincts, this is the time to remain disciplined and rebalance. For those of you feeling distressed, confused, or anxious talk to your coach and get your questions answered. Your long-term peace of mind is on the line.

Fox News interview with Mark Matson

Mark and Jenna Lee discuss the recent market drop, the economy, and unemployment. The message to investors is to ignore the Wall Street hype and horror, focus on long-term, and rebalance on the lows in the market.