ATA_2013_10_01_GregoryFriedman_235x130-250-resize-600x338Now that 2014 is firmly underway and we have had a chance to look back at the market’s strong returns in 2013, the subject of rebalancing seems logical.  Behavioral studies on investors have shown that it is very difficult to consistently pick the tops and bottoms of markets.  As a result, the best tool for both controlling risk and ensuring long-term steady performance is to systematically rebalance our portfolios to a strategic allocation.

A strategic allocation is the long-term allocation between asset classes (stocks, bonds, private equity and many more) that maximizes your return for a particular level of risk.  This “resetting” of the portfolio helps ensure that you don’t become over exposed to certain asset classes as a result of their performance (or lack thereof).  For example, in 2013 the equity markets had a tremendous year.  This performance likely pushed your equity allocation up relative to its long-term allocation.  While none of us knows with certainty whether the market will go higher or lower from here, one thing we know is that we want to buy low and sell high.

Looking at your portfolio each January can be a helpful way to make sure that your portfolio is positioned properly.  Perhaps this hypothetical example will help: in 2013 you started the year with an allocation of 50% bonds and 50% global equities.  During the year equities outperformed and now, a year later, represent 70% of your total portfolio.  In contrast, bonds now represent only 30% of your portfolio.  This deviation has significant impacts to your risk and return tradeoff.  A simple calendar rebalancing would be to sell enough equities and buy enough bonds to get your allocation back to 50/50.  This returns you to your desired long-term risk reward tradeoff and helps to further the “buy low, sell high” mantra.  The basic premise can be applied to a portfolio of individual stocks or one with multiple asset classes.  The key is to identify your desired allocation and rebalance to it.

In many cases rebalancing once a year (whether it is in January or another month) can be a easy and simple way to stay on top of your portfolio.  Successful long-term investing does not have to be a daily process.  In fact the simple process outlined above can do wonders to help ensure that you stay the course and not get greedy during big up markets and scared off during down markets!

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