Investors in the markets over the past few years know
exactly those emotions. As stocks sank in the 2008 swan dive during the credit crisis, part of the downward slide was fed by small investors panicked by the prospect of losing their nest eggs. “If you burn your hand on a stove, your fight-or-flight
emotion is to jerk your hand away to stop the pain. When you see your portfolio declining rapidly, like they did in 2008 and 2009, our natural reaction is to end the pain at any cost,” Kimball says. So people sell and put the cash into money market accounts, then wait. Inevitably, they get back into the market far too late, well after equities have recovered and are once again expensive. “They basically do the opposite of what they are supposed to do. They buy high and
Rebalancing takes the
emotions out of investments.” — Chris Kimball
sell low,” Kimball says. The key to rebalancing is to do it systematically, Kimball tells Newsmax. “If the market has a huge swing, that might not be a bad time to rebalance, but stick to your targets,” he says. “Rebalancing is boring. But my advice in investing is, Slow and steady wins the race.” How often is enough? There have been stacks of studies
on the issue, but one very thoughtful review by cheap-fund pioneer Vanguard Group offers a good starting point: Do it once or twice a year, but only if your positions exceed their targets by 5 percent. At that frequency, you get the benefits of rebalancing while minimizing trading costs.
WHERE TO PUT YOUR MONEY I ocations 20% 20%
Large-Cap Stocks Mid-Cap Stocks Small-Cap Stocks International Stocks Emerging Markets Stocks Intermediate Bonds Short-Term Bonds
ocations 20% 30%
SOURCE: American Association of Individual Investors
AGGRESSIVE
Strong focus on riskier investments, such as small-cap stocks.
Aggressive Allocations 10% 10% 20% 20% Moderate Allocations (0% Short-Term Bonds) 20% 20% 20%
THE STOP-LOSS: LIMITING THE DOWNSIDE
D
o not trust rebalancing alone to erase risk, warns John Graves, author of The 7% Solution and an independent financial adviser in Ventura, Calif. “Rebalancing is a function of asset allocation, and asset allocation flows from modern portfolio theory,” Graves says. “Modern portfolio theory works nicely 80 percent of the time, but when the market is in extremis, it fails.” In other words, during times when the
GRAVES
entire market goes down, rebalancing doesn’t work because there is no place to hide. “In 2007-2009, all asset classes declined and all at the same time,” says
Graves. “There was no hiding place. There was no shelter.” Graves instead is a proponent of setting an income target and then buying individual securities that will allow you to meet your income number. Rather than picking winners and losers, he says, limit the downside of any one position using a stop-loss, a type of automated sell order your brokerage can set up for you. “The markets are a lot smarter than any of us individually.
Aggressive Allocations 10% 10%
If I pick a security and it goes down 10 percent, I walk away and buy something else,” Graves says. Much like Warren Buffett’s mentor Ben Graham advised,
20% Aggressive Allocations 10% 10% 20% 20% MODERATE
Intermediate bonds are the focus, but a healthy weight in stocks too.
Moderate Allocations
Large-Cap Stocks Mid-Cap Stocks Small-Cap Stocks International Stocks Emerging Markets Stocks Intermediate Bonds Short-Term Bonds
30% 20% 5% 15% 10% 10%
Conservative Allocations 25%
(0% Short-Term Bonds) 10% 5% (0% Emerging Markets Stocks) AUGUST 2012 | NEWSMAX MAXLIFE 73 20% 20% 20%
it’s better to buy stocks that are cheap compared to their book value, have low debt and strong free cash flow, and offer sustained and increasing dividends, Graves explains. “It’s what made Warren Buffett a billionaire. Buy a business, not a stock,” he says. “It’s old-fashioned, but it works.”
20% Moderate Allocations
nvestors are often told to rebalance according to an asset allocation model. While no single model or selection of assets fits all investors, here are three starting points to consider — aggressive, moderate, and conservative.
5% 15%
Large-Cap Stocks Mid-Cap Stocks Small-Cap Stocks International Stocks Emerging Markets Stocks Intermediate Bonds Short-Term Bonds
30% 20% 10% CONSERVATIVE
Conservative Allocations 25%
Bonds are the anchor here, also a focus on large caps.
10% 40% 10% 20% 20% 20%
Large-Ca Mid-Cap S Small-Cap Internatio Emerging Intermed Short-Ter
GRAVES/COURTESY OF THE RENAISSANCE GROUP, LLC
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