Keynes was a demand-side economist who believed that Government spending is the answer to a healthy economy, he promoted social liberalism. Friedrich Hayek was a supply-side economist promoting free market capitalism. This video is the second in a series. I met these guys in Austin, they and their Director, John Papola (formerly with Nickolodeon) are doing a great job educating people of all ages in a fun format.
You’ve probably heard me mention the Three Rules to Lifelong Investing Success: Own equities, Diversify and Re-balance.
While it sounds simple, there is really a science behind all three. In this post, we will focus on the third rule, Re-balancing.
A prudently designed portfolio will contain asset classes that have low correlations to each other meaning, when one investment class moves down in the market, the other may move or remain. This is intended to bring some “leveling” to your portfolio without giving up gains.
In looking at the benefit of Re-balancing, let’s take a hypothetical portfolio made of 50% “Fixed Income”, containing more conservative asset classes, and 50% Equities, made up of many individual stocks, globally diversified.
Reviewing your portfolio quarterly, assume we notice that your “Fixed Income” portion has grown to 60% of your total portfolio, while Equities now represent 40%. Conventional thinking may be to “Buy more of what’s growing!” But what the prudent and disciplined investor does is Re-balance.
In this scenario, selling a portion of the “Fixed Income” while it is relatively high, taking the proceeds and buying more of the Equities while they are relatively low, brings you back to your predetermined Investment plan of 50% Fixed and 50% Equities. This not only Re-balances your portfolio, but brings long term profits by staying disciplined in keeping with one of the key rules of investing: Buy when prices are relatively low, sell when prices are relatively high.
A study by research and analysis company, Dalbar Inc, reports that while the S&P 500 averaged 8.20% for the 20 yr period of 1989 through 2009, the average mutual fund investor earned only 3.17% during the same 20 yr period.
Why such a huge difference? Many individual investors, instead of staying disciplined and re-balancing as outlined above, will instead chase “hot” asset categories, inadvertently forsaking diversification. For example, an investor may see that “tech” stocks are taking off (prices moving upward) and, not wanting to “miss out” sells his other holdings that are down and buys the “hot” category while it is up. this type of investor will lose out on having “dissimilar” price movements and may fall into panic trading.
While most have “Buy low, Sell High”, many lack the discipline to actually buy more of an asset class that is moving down. By systematically re-balancing when your asset classes move out of your pre-determined percentages, you can avoid panic and benefit from long term growth and profits.
(Past performance is not a guarantee of future results)
(Past performance does not guarantee future results)
The Free Markets are among many things that make America Great!