I am aware of the fact that one should not time the market. However, I am not sure if the following strategy falls under the term "timing the market". Say I have 100k cash of which I decide to invest 40% into an index. Assume that the market then drops by 20%, e.g. my intial 40k invested are now 32k in value.

If I now sum my remaining cash capital of 60k plus my portfolio value, I end up with 92k. So 40% of my total capital would be now 36.8k. Is it a reasonable strategy to increase my index portfolio by 4.8k to remain a 40% ratio (invested:total capital)?

Following this stragety I would just stay the course if the market rises unless my cash capital grows faster than the market percentage wise (then I would also correct the ratio by increasing my investments) and stay the course + add something to my portfolio if the market drops.

What are your opinions on this strategy?

  • This is a common strategy; if you want insight into how it performs, get a couple decades of historical data and a spreadsheet and work out how your strategy would have performed at different points in history, and then compare that to other strategies like "put it all in a mattress" or "put it all in an index fund and never rebalance". – Eric Lippert Feb 28 at 22:33
  • If you like the strategy but don’t want the work, then there are balanced funds that will do the work for you. – Mike Scott Mar 1 at 10:04

What you are talking about is rebalancing your investments. Some people do that once or twice a year. Others never rebalance.

Some people don't like it because it hurts to sell winners and buy more losers. Others don't like it if there are transaction costs, or tax impacts. Certainly if you rebalance too often (weekly or monthly) you can be making a lot of work for your self. It can also be more complex if some of your investments are taxable and some are in tax deferred or tax exempt accounts.

Some investors make the changes more passively. They look at the balance between different sectors : large companies, small companies, bonds, international funds and fixed income; and then decide that all their investments for the next year will be done to bring them back towards the desired proportions.

Rebalancing isn't an example of trying to time the market. You are still following your plan, you are just checking your progress more often. If you were timing the market you would be making large movements based on big guesses.

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  • 3
    I found this book The Intelligent Asset Allocator (Bernstein) invaluable when I started investing. 1) Makes the concept of asset allocation - and rebalancing - very clear. 2) Has plenty of examples. 3) Best of all: Has easy to understand charts that show, for example, expected gains over time for different bond/stock allocations. Those charts opened my eyes! Especially to the large reasonably flat section between 40/60 and 60/40! Showing you don't have to be really precise in that range ... – davidbak Feb 29 at 0:11

I think your strategy is a good start, but it needs more rigorous rules and a schedule so you don’t have to figure out what to do every time you look at your portfolio. Let me show you how I’ve been doing it. (There are many methods. This one is mine.)

I’ve been rebalancing my diversified portfolio for more than 10 years. To keep my sanity and to avoid the impulse to time the market, I will rebalance not more than once per calendar quarter, in the first week of the quarter, based on account balances on the last day of the quarter just ended. The bloodbath in the stock market that happened this week has nothing to do with me, since I’m not touching my investments until my next scheduled rebalance in the first week of April. No. Matter. What.

Rebalancing (for me) is triggered by classes or categories of investments falling outside of specific tolerances that I’ve decided upon in advance. For purposes of this explanation, a “class” is something like “Domestic Large Cap Value” or “International Small Cap Growth.” And a “category” is something like “Domestic Equities” (composed of 5 classes of domestic equity) or “Real Estate” (composed 2 classes of real estate).

Under my plan, every class and category has a target percentage of the portfolio and a tolerance window. All classes have a tolerance of +/- 25% and all categories have a tolerance of +/- 5%. If something falls out of tolerance, I rebalance it by buying or selling enough of it to put it back within tolerance, reasonably close to its target percentage. If it’s in tolerance on the last day of the quarter, I leave it alone.

As an example of a class, if “Domestic Large Cap Value” has a target of 5% of the portfolio and a tolerance of 25%, it is within tolerance as long as it remains between 3.75% and 6.25%. (That is, 5% * 0.75 and 5% * 1.25.)

As an example of a category, if “Domestic Equities” has a target of 40% of the portfolio and a tolerance of 5%, it is on-target as long as it remains between 38% and 42%. (That is, 40% * 0.95 and 40% * 1.05.) If a category is out of tolerance, then the classes that make up that category are surely out of tolerance, and rebalancing the categories takes care of the classes. Remember that all the percentages must always add up to 100%, so if something is over target, something else must be under target.

Most years, rebalancing has only been required once or twice a year, since the other quarter-ends have stayed within tolerance on their own.

The point is, if you give yourself rules to follow, it takes the emotion and worry out of the task, and it becomes nothing more than a mathematical problem to be calculated on a schedule. Rules and an unbreakable schedule help you to be a wise investor by helping you to avoid badly timed transactions that are driven by emotion, fear or a feeling that you can predict the future.

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First, you should revisit that "don't time the market" advice. First, understand where it came from. Stock brokers have a problem: they are supposed to watch the market and advise their customers, but if they make a mistake, they don't want the customer coming back around and saying "well, well, you told me wrong and you should be responsible for my losses". They also want to take the little people's money anytime they walk in the door, and not turn them away merely because market prices are not favorable right now. For business reasons they must have you believe it's always a good time to buy stocks. So they create this meme of "you can't time the market".

I don't have anything against trading strategies or doctrines, but they're not a suicide pact. You shouldn't follow the doctrine beyond reason, i.e. When facts on the ground are telling you something totally different. The first law of investing is Buy low, sell high, and that trumps every other strategy or doctrine.

If CNN has gone into 24-hour-coverage mode about the tanking of the stock market, and brokers are jumping out of windows, then go look at fundamentals. Did they also tank? If the fundamentals are still solid and the stock is underpriced because of panic, then it is low and you buy.

Brokers don't want to be financially responsible for telling you to do that, and don't want to deter you from investing at other times, so they won't tell you to do that. But are they doing that? Are their bosses doing that? Are investment bankers doing that? *Oh you betcha... that's who the buyers are, when ignorant sellers panic and sell low. If they really believed "don't time the market", then they wouldn't be doing that kind of opportunistic investing, would they? :)

So yes. When Wall Street is having a half-off sale, you certainly should be flipping over couch cushions to invest money that you wouldn't otherwise have invested.

So I hope I have disabused you of the notion that timing the market is "ooga booga" bad.

Rebalancing is the best and surest way to time the market

And back to, "this is what the pros do with their own and with institutional money". Rebalancing is gold-plate strategy for endowments, for instance, which are supervised by the smartest investment bankers in the world, as part of their role on university boards.

And back to the laws of investing, you are absolutely correct: rebalancing means you buy low when low stock prices have shrunk its fraction of your portfolio, and you sell high when high stock prices have made them an outsize proportion of your portfolio.

And you are correct that "buy low, sell high" stands in direct contradiction to "don't time the market". Both can't be correct at once. "Buy low" is correct, "don't time" is wrong.

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  • Would you mind explaining what you mean by "go look at fundamentals" for the uninitiated? What are these "fundamentals"? – user541686 Mar 1 at 11:31
  • Unless they have a magic crystal ball that tells them when shares are low and about to go up again, or high and about to go down again, then "buy low sell high" is pretty much useless advice to the average investor. They could buy shares when they are low, then the company goes bust and the shares are worthless. They could sell high, then the shares keep going up and they missed out on a large profit. – Simon B Mar 1 at 22:29
  • @SimonB that's more rationalization to support the "can't time the market" theory, i.e. "The theory is correct therefore the rationalization must be true". Talking like it's some sort of mystery when stocks are very high or very low. Believe me, in 2009 everybody knew. I didn't buy at the bottom bottom, but within 20% of the bottom. And I sold not at the top top, but close enough. It's not rocket science to know when you're in a recession. The only hard part is remember "buy low sell high" when everyone else is freaking. That requires confidence. Your talk endangers confidence. – Harper - Reinstate Monica Mar 1 at 23:37

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