Finance Watch-outs: rebalancing dangers to look out for Most of the time, rebalancing doesn’t involve major decisions ‒ it’s more about tweaking and fine-tuning than it is about a whole scale tear-down of the portfolio. That said, there are some occasions in which rebalancing can bring up some problems, and some emotional challenges for the investor. The next time you rebalance, look out for the following pitfalls. Portfolio paralysis You know that it’s time to rebalance. Youwant to rebalance. In fact, you’ve been thinking about it for weeks. And yet…something is standing in your way. Chores and other personal events prevent you from sparing a few hours. Or, you convince yourself that the market isn’t “right.” And so you end up doing nothing. Now, there are times at which sticking with the status quo is exactly the right thing to do. In fact, in the face of a market downturn, doing nothing is often the prudent course of action. And, over the short term, putting off your rebalancing for a few weeks or a month probably won’t matter all that much. However, if you keep on putting off rebalancing, you could create an ever-widening gulf between your current portfolio and your ideal allocation targets. Here’s the thing: there will always be a “reason” to put off rebalancing ‒ an event or circumstance (whether personal or market-related) that makes you wonder whether now is the right time to rebalance. The trick is to make sure that such events don’t lead you into long-term paralysis. Instead of worrying about the “perfect” time to buy or sell, trust the process. Emotional attachment Rebalancing often requires selling investments that have been doing well and reallocating to those that haven’t. But just as often, it can involve clearing out the “debris” of a portfolio ‒ the ideas that didn’t work out, positions that have lost money and investments that have stubbornly refused to live up to our expectations. Both sides of this process can sometimes be emotional. We might have fallen in love with great ideas which we identified before anyone else, or great companies that sell wonderful products. Conversely, we might be reluctant to “own up” to problems that, in hindsight, we really should have foreseen. And these emotions can sometimes get in the way of the rebalancing effort, making us reluctant to do what’s necessary. Part of the reason why we rebalance is to deal with these kinds of emotions ‒ to make buying and selling less emotional and more process-driven. Instead of celebrating our success or facing our financial shortcomings, we’re simply sticking to our investment process. It’s less positive/negative and more neutral. Of course, it doesn’t always work out like that. Even the most experienced investors sometimes find themselves anxious about a particular rebalancing decision. One simple way of dealing with it is to imagine that you didn’t hold your current asset, and then ask yourself: “knowing what I know now, would I buy this today?” If the answer is yes, then keep it. If there’s a moment of hesitation, then it makes sense to sell and rebalance the proceeds. This exercise eliminates much of the emotion that comes with our history of holding a given asset ‒ the inherent desire to keep a holding that proves how smart we are, or to hang on to a bad idea in an effort to salvage a win out of a losing position. Obsessive tweaking As we discussed above, most academics and investment researchers believe that rebalancing is an important part of a successful long-term portfoliomanagement strategy. But there’s no evidence that the more frequently you rebalance, the better your portfolio will be. In fact, if you take the time to get your baseline allocation right, and if markets are relatively benign for a long period of time, it could be months or even years before you need to actually rebalance. In theory, this is nothing to worry about ‒ if anything, the less you rebalance, the more you save in transaction costs. In practice, however, some investors can find this lack of action somewhat troubling. They feel the need to “tinker” ‒ to make minute tweaks and small adjustments, even if there’s nothing really wrong with the allocations in the portfolio. No, it’s not necessary. But it makes them feel better. Don’t fall into this “change it on Monday and change it back on Tuesday” kind of approach. Excessive tinkering with your allocations can generate a lot of trading fees and other transactional costs, which can really eat into your gains over time. It also distracts you from the ultimate goal of rebalancing: long-term, big-picture riskmanagement. 32 | www.snowbirds.org
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