Rebalancing your portfolio is a great strategy for investing.

Can we time when to be in the market and can we pick specific individual stocks that outperform the general stock market over the long run is a question that has been asked over and over again. We will in this article talk about some historical facts and also discuss how we as investors can obtain good long term results inside of our portfolios.
So extremely simplified there are 2 types of investment styles; active market timing where a fund manager tries to get in and out of the market whenever they find it advantageous and such a fund will also try and forecast which sectors in the market will perform better on a forward looking basis.

On the opposite spectrum of the active management style there is a more passive theory based more on a long term disciplined approach. This passive approach believes that the market is efficient and that all information is readily available for all investors.

Rebalancing is the process of making sure that the portfolio is invested within the framework that originally was planned.

So let’s try and look at some historical data and see how portfolios have performed over time. Dalbar*, a company that analyzes investor and fund returns, showed that the average investor over the last 20 years earned an average 5.19% rate of return inside of their equity portfolio. During that same 20-year study period the S&P 500 averaged 9.85%.

 

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So why did the investor lack the market and why is the gap so great?
Mutual funds and investment platforms have fees and we can safely assume that 2% may have been lost to fees but we are still missing another 2% of lost returns. The only real explanation has to be that it was lost due to market timing and/or lost due to individuals or fund managers trying to predict which sectors and countries to be invested in at specific periods.
So based on those facts the passive investor who does not try to time the market would seem to have done better over that 20-year period and would have had the ability to grow their money at a higher rate of return.
One factor though that becomes extremely important when looking at passive strategies is to be sure the passive strategy involves an active rebalancing plan. Rebalancing is the process of making sure that the portfolio is invested within the framework that originally was planned. An example could be that someone wants a portfolio with 80% stocks and 20% bonds but after a year stocks dropped in value due to a market correction and now the portfolio looks more like a 30% bonds and 70% stock portfolio. This is the time where some bonds would be sold and stocks purchased to recreate the initial 80-20 setup.

Rebalancing is the process of making sure that the portfolio is invested within the framework that originally was planned. An example could be that someone wants a portfolio with 80% stocks and 20% bonds but after a year stocks dropped in value due to a market correction and now the portfolio looks more like a 30% bonds and 70% stock portfolio. This is the time where some bonds would be sold and stocks purchased to recreate the initial 80-20 setup.

This is the time where some bonds would be sold and stocks purchased to recreate the initial 80-20 setup.

So there is not necessarily a right or wrong way of building a portfolio but no matter if active or passive is the strategy there should be a plan to make sure the portfolio is rebalanced at all times.

* Quantitative analysis of investor behavior 2015” Dalbar, Inc www.dalbar.com

Written By CreativeNurse team
2016-27059 10/17