Commandment 7: Don’t Speculate, Rebalance
This is the seventh of a ten part series where we look at Haven’s Ten Commandments, a short list of investing fundamentals we like to teach to our clients. It’s nothing too fancy, but a good foundation we believe everyone should understand.
For a car to work at peak performance, there’s a multitude of factors that go into making sure it runs to perfection. You have to make sure the oil is fresh, the tires are properly filled, it’s equipped with the right fuel, belts and filters are in good shape, an overall inspection to make sure everything is right. And you need all of these components to be running and working together. If everything is perfect except for one thing, the outcome won’t be optimal. Ever tried to drive a car with something obviously out of order? This combination of everything working in unison is what can make you have the edge in competition above the rest.
In our last commandment, we discussed how Dr. David Swensen, who has run one of the most successful endowment funds in history, believes asset allocation is the most important factor when considering what impacts your overall portfolio performance. Contributing to about 90% of the overall importance.
So that leaves us with a question what 10% of our investment vehicle is keeping us from operating at peak performance? We may have the big questions nailed down. But how can we maximize?
The answer? “Timing” and “Selection”. In this post we will take a look at Timing specifically and why it matters.
Although the market moves up and down over time with wide variations, it is nearly impossible to tell exactly where it will go in the near term. You can have an idea that it will move up or down, but to what degree is just a guessing game. In the collective wisdom of markets that we’ve gained over time, a common saying emerges, “it’s about time in the market, not timing the market”. Simply, you need to be playing the long game to reap any rewards. You can’t make money consistent gains in the markets, never mind staying on track to achieving your goals, through speculation alone.
Trying to perfectly time the market is impossible, and even if you buy in at a low, it doesn’t mean it won’t go lower. So instead of going to your local fortune teller, and praying, it’s much easier to start investing properly: make regular contributions and rebalance.
Making regular contributions ensures that you are always saving, even if it is a little bit to start, one day you’ll look at your portfolio and be amazed by how much you’ve saved through an act that became a monotonous habit. By saving the same amount consistently, you’re effectively buying more units of a given investment when its at a low, and less units when the prices have risen. This automated system allows you to be aggressive when prices are low and conservative when prices are high.
It’s the idea of getting rich without knowing it. Money automatically transfers from your bank account to your portfolio when you get paid, so you don’t even get a chance to notice or spend that money. This idea is discussed in length (along with many other simple to execute ideas) in the books: The Richest Man in Babylon, The Wealthy Barber and The Automatic Millionaire — all highly recommend books.
Rebalancing is essentially another way of saying “buy low, sell high” — but rather than using guesswork, using a system.
In previous posts we’ve talked about how over time investments will fluctuate but will generally follow and upward trajectory. So the laws of “mean reversion” apply especially well to markets. “What goes up, must come down”. Oversimplified, when markets are above their long term trend line, this signals they will likely have to move down, and vise versa.
If you’re set up to invest properly you will have done so based on your risk tolerance, goals, and timeline. Based on this, you will have an appropriate asset allocation — broken down to a mix of stocks, real estate, and bonds (potentially other asset classes also). As an example let’s take an allocation of 50% stocks, 30% real estate, and 20% bonds. Let’s pretend over the course of a year stocks performed incredibly well, along with real estate, and bonds didn’t do so hot. Since the values of your proportions fluctuation, now your actually asset allocation might look like 55% stocks, 35% real estate, and 10% bonds.
What we’ve learned in mean reversion is that what goes up must come down. We are anticipating that stocks and real estate will eventually run out of steam and decline, while bonds should pick up the slack. By rebalancing to our original asset allocation of 50/30/20, we are forced to sell investments that have gone up and we expect will go down (limiting downside), and reinvesting the proceeds into what has gone down and can expect will go up (capturing upside). This is a small but crucial piece of strategy to make the most of your returns.
At Haven we offer portfolio options with regular automatic rebalancing, and automatic transfers (which are automatically invested throughout your diversified portfolio) that can be easily set up and changed if you need (money can get tight). This way you can take advantage of strategies the pros implement without having to even think about it.
If you have any questions about timing and rebalancing, investing in general or learning about how Haven can help you, don’t hesitate to contact us.