Weather the Stormy Market with a (Re)Balanced Portfolio
There are sellers, there are buyers, and there are investors doing nothing. In this stormy market, who are you?
I think I belong to the third group with a little bit buy activities. Rather than seeing the current market as the prelude of a recession as some have predicted, I treat the month-long decline as a buying opportunity, though I won’t be on any kind of shopping spree. My strategy is keep buying funds that I have been investing for years and, at the same time, adding a little bit more here and there when I feel the time is right. This approach was used in the last recession (early this decade) and it has really paid off as those shares purchased 5 or 6 years ago are making big contributions to the growth of our nest eggs.
Then, is there anything else investors should do to weather the market? The answer is yes and what investors can do is maintaining a balanced portfolio that is rebalanced periodically. That’s main message from an article on yesterday’s Wall Street Journal. The article, Staying Balanced in a Wild Market (free) by Jonathan Clements, argues that for investors looking for long-term benefit from the current market, it’s better to act now than stay idle and wonder what to do next. And the right course of action is buying the sector that has been beaten down, if that sector is a component of a balanced, well diversified portfolio.
For a diversified portfolio (here are some examples of model portfolios) that invest in, say, both domestic and international stock markets, as well as bonds, real estate, precious metal, the allocation to each category (i.e., the portion of assets invested in each category) could change over time and the asset allocation may drift away from the target as some sectors outperform (international) while others lag (real estate) the general market. However, it’s important to maintain the target percentages because the portfolio was constructed based on investor’s investment objective, time horizon, risk tolerance level, and return expectations, etc.
The article used an example to show how rebalancing could be done. If you have a portfolio that has
30% large-company shares, 10% small stocks, 3% real-estate investment trusts, 2% gold shares, 12% developed-foreign stock markets, 3% emerging-market shares, 20% high-quality short-term bonds, 15% inflation-indexed Treasury bonds and 5% high-yield junk bonds.
After reviewing your investments, you find that the initial allocation is lost because one particular sector in this portfolio has been hit hard and that’s REIT. To rebalance and get REIT back to the 3% target, you need to add more money to the REIT fund, which now you can buy at cheap. The money can come from selling some emerging-market funds which have gone over the 3% target due to the strong performance of oversea markets. Or it can be fresh cash to avoid selling shares and incurring taxes.
But what if real estate keeps going down? I will lose more money if I keep buying, right? Right, that could happen. However, if you plan to hold your investments for 20, 30 years, why that matters? As Clements says in the article:
Nobody, of course, knows how the sector will perform in the months and years ahead. Still, if you own a well-diversified collection of these stocks through a real-estate fund, you can be pretty sure you will make decent money over the long run.
This article was originally written or modified on . If you enjoyed reading this post, please consider subscribing to my full RSS feed. Or you can also choose to have free daily updates delivered right to your inbox.