Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It only takes a minute to sign up.
Sign up to join this community
I understand the notion that I need to determine an asset allocation based on my risk preference and then rebalance annually or biannually to keep my asset allocation in line.
However, consider that I start with a 60-40 equity to fixed asset allocation. After year 1 my allocation (because of incredible equity performance) becomes 80-20. Why do I want to rebalance down to 60-40? Possibly my initial asset allocation was not correct and I really want an 80-20 split.
Same principle as what everyone wants to do: Buy low sell high.
Assuming that the investments were chosen on sound principles and you still believe they will be good performers in the long term, you sell the winners and buy the losers in the short term. So if you believe the losers (the now 20%) are still good investments for the long term you sell the winners (the now 80%) high to buy more of the losers low.
Ten years from now you may have a couple of years where it goes from 60-40 to 40-60. So you're erstwhile losers are now winners and vice versa.
So with sound investments that perform well over the long term you are always buying low and selling high in the short term. This only works if the investments are good investments. If the losers are always losers (for many years) then this would be very bad.
Changing plans midstream s a good way to burn yourself. If you had a reason for the 60/40 split, and that reason hasn't changed, your last sentence is nonsense.
That reason probably came from the fact that bonds tend to move in the opposite direction from stocks in the short term, and a balanced mix of these damps out those swings. For that to work, you need to be willing to recognize that when stocks are high and bonds low you want to move money from the former to the latter, selling high/buying low in preparation for the next shortterm swing of the pendulum
It's always tempting to hold onto the investment that's doing well. But remember past results are no indication of future performance, and the market may start moving in the opposite direction. If you left the money in the stocks that could wipe out your gains. Trying to guess the ideal point is somewhere between difficult and impossible; it's a lot easier and more reliable to make a plan and follow it..
