Monday, March 4, 2013

To Re-Balance Or Not To Be

During my first year in the Army, I was trained in the strategy and tactics of conventional warfare.   During my second year, I was trained in unconventional warfare.  I've always felt that this one-two approach to almost any subject has served me well.

According to Wikipedia, conventional wisdom is "the body of ideas or explanations generally accepted as true by the public or by experts in a field. Such ideas or explanations, though widely held, are unexamined."  Unconventional wisdom is the opposite, but does that make it wrong?  Of course not!

According to conventional investing, portfolios should be "re-balanced" periodically.  An example would be to sell stocks and buy bonds after a bull run in the stock market, because stocks would be a higher percentage of your portfolio than you might be comfortable with.  If you want your portfolio to be 60% invested in stocks and it is now 65%, you should sell stocks equal to 5% of the portfolio.  Like most arbitrary rules, it is more interesting than valuable.

How does one reconcile the notion of re-balancing with one of The Street's oldest adages:  "Ride your winners and sell your losers"?

The answer is they cannot be reconciled.  Re-balancing can be accomplished by computer programs without any human input.  It gives the impression of action, even when none is needed.  If you think the market will continue rising, why would you want to reduce your exposure or get out?

Re-balancing is not bad.  In fact, it is good.  But, it should be done when your investment perspective changes, not according to some calendar.

If you want to reduce risk, then by all means, sell some stocks.  But, don't buy long-term bonds when interest rates are low, like they are today.  A computerized program to sell your stocks and buy long-term bonds is virtually guaranteed to lose money for you.  Beware of arbitrary rules!

Of course, part of unconventional warfare is dis-information.  And, reliance on such arbitrary rules like periodic re-balancing, especially computerized re-balancing, is the same as relying on dis-information.  It is like fighting an unconventional war with conventional tactics.

See . . . I did learn something in the Army!