So what if I’m afraid to rebalance?
Theoretically we get it—buy low, sell high. But what if the sheer thought of rebalancing your portfolio to preserve your asset allocation makes you panic? Larry Swedroe explains how to face your fears.
Tim Maurer back with another episode of Ask Buckingham, a new video podcast designed to bring clarity in the midst of confusion by connecting your great personal finance questions with straightforward answers from industry thought leaders. Today’s thought leader is Larry Swedroe, Buckingham’s chief research officer. And Larry, what if I’m afraid of rebalancing? What if my 60% stock 40% bond portfolio just turned into a 50, 50 portfolio and I don’t really want to take from the bonds that are stabilizing my portfolio and buying more of the stocks that seem to be falling right now? Do I really have to rebalance if I’m afraid to do so?
The good news, Tim, is I think the answer to that is no. But I want everybody to understand the logical answer and then we’ll deal with the psychological event answer. Because we know we as human beings are not purely logical. Our stomachs get roiled, especially when we see periods of crashing markets. And the only light at the end of the tunnel is that proverbial truck coming the other way. One thing, let’s start with the logical. History tells us we get out of and recover every single time from these recessions and their markets. It doesn’t mean it can’t get cheaper from here. We’ve had much cheaper bear markets than down 37% which I think was the high to low so far this time. In ’08 we went down about 60%, so it can get worse and you may face having to rebalance one more time.
And you have to accept that possibility. But again, the evidence says if you stick with that plan and are disciplined rebalancer, you will come out almost certainly ahead in the long term, can’t be a guarantee or there’ll be no risk. But the problem is fear takes over here and we’re afraid that if we buy the next day it’s just going to crash again. And we will often engage in is hindsight bias. We will think it was painfully obvious that we should have seen that this was coming. Why did I do it? And that’s really difficult for people to live with as well. Having lived through the ’08 crisis where many people were panic selling and we as advisors, we’re trying to make sure we talk them off that ledge of what I call committing portfolio suicide. Because once you sell, it’s almost impossible to get back in because there’s never that green flag that tells you it’s safe to invest.
If you’re fearful of rebalancing fully, I want to help you by giving you two alternatives, which I would consider to be minor misdemeanors rather than this felony of panic selling. And if they achieve that goal, we’ve done our job by helping you do that. The two options I want to throw out, and you should choose the one that you are most able to stick with and here they are. If you’re 60, 40 your target is 60 but and you’re rebalancing band on the bottom is 55. Let’s say you’re with 55 and the next day the market dropped 10%, you’re down to 50. To rebalance, you have to buy a full 10%. That’s really difficult for people to do, especially just as the market has crashed. Maybe Warren Buffet is in the 1% of the investors who could actually do that buy when there’s blood on the street. Most people can’t.
Instead of trying to [inaudible 00:04:00] you to buy all the way back to your target, one option would be to just buy back to your minimum, which would be 55%, so buy 5% instead of 10. And you don’t want to check every day now because tomorrow if it goes down even a little bit, you’d have to do it again. I would suggest setting a date, write your plan down that’s important and stick with it and come back in two weeks or maybe better one month. And if you’re still below your minimum rebalance again but only to the minimum. The other option is instead of rebalancing to the minimum, let’s just rebalance 1% and we’ll come back again in a month. Now, here’s the way I want you, if you choose either of those alternatives, you need to think about this. If you buy and get to the minimum or by 1% and the market begins its recovery like it did on Tuesday, you should congratulate yourself that you at least got started.
You didn’t stick with your plan and get right back to your target, which in hindsight would be a big win. But at least you didn’t panic and sell and you did buy some and you have a nice gain from that. On the other hand, if it collapses again, then what do you think? Well, congratulate yourself that you didn’t rebalance all the way to your target or all the way back to the minimum band. Either way you made the right decision and you will feel better and that will be very helpful. We want to make sure you don’t commit portfolio suicide, that felony minor misdemeanors can be forgiven, and you can forgive yourself. One last point, Tim, is really important that we need to make. Our strategy at Buckingham on bonds has always been that bonds are not there for yield or income.
They’re there to make sure we dampen the risk of the overall portfolio into an acceptable level. And they serve as that anchor that keeps our ship safe in port. In a storm, they tend to go up during periods and now when we need to buy stocks which are down, our bonds have actually risen in value typically, not always, but as they’ve done now, as yields collapsed, we can now sell those safe bonds generally at high prices and buy stocks cheap. If on the other hand, as many investors did, when you get very low interest rates, they shift towards high yielding securities like junk bonds, like real estate, dividend paying stocks, MLPs, preferred stocks. They shouldn’t make that mistake because the lesson was taught to them in ’08, every one of those went down 25, 35, 50, 60% and now you can’t rebalance. You can’t buy your stocks cheap because you’ve got nothing that went up in value or went down much less. Now the strategy of sticking with the safest bonds really is paying off for investors and a reminder why we stick with that strategy.
Thank you so much, Larry. Thank you for your willingness to compromise in a sea of financial voices that seem only to speak in absolutes. And thank you for tuning in to this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website, askbuckingham.com or emailing your question to firstname.lastname@example.org or just click in the corner of the screen, it’ll take you directly to the website. Remember, there are no dumb questions, but unfortunately there are plenty of poor answers out there. Our hope is that in giving you straight answers
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