Guest Author - Tony Daltorio
In prior articles, we have discussed some of the so-called conventional wisdom that Wall Street that likes to promulgate. We have discussed how buying and holding an index fund is a losing strategy and also how keeping your eggs in one basket (the US stock market) is also a losing strategy.
Another piece of conventional wisdom that Wall Street and many financial advisors tell their clients to do is to re-balance their portfolio at least annually. This 'advice' is just a nice way for financial advisors to collect commissions and/or fees from their clients at least annually.
What does re-balancing a portfolio mean? For simplicity's sake, let's say a client has 4 sectors in their portfolio - US large cap stocks, US small cap stocks, international stocks, and bonds. Let's assume each sector started with 25% each. At the end of the year, the portfolio now has the following: bonds-25%, US small cap stocks-20%, US large cap stocks-15%, and international stocks-40%.
Many financial advisors would tell the client to sell the international stocks to get it back down to 25% and buy the US stocks to get them back up to 25%. That way everything is back in balance again. This is absolutely the wrong strategy! This strategy only ensures that the client won't make much money long-term in the market and that the advisor get his fees.
If a person were a hedge fund manager on Wall Street and followed that strategy, they would not be in that position for very long. That person would be fired for being an incompetent money manager. The whole idea is to make money. One of the keys to long-term successful investing in the stock market is to let your winners run and to get rid of your losers as soon as possible. You don't see successful investors like Warren Buffet re-balance their portfolio every year! I cannot envision Warren Buffet thinking to himself -"Gee, I made too much money there this year, I better sell it."
In the above example, the client would be best advised to do nothing for the moment and not robotically re-allocate. The only exception would be if one non-diversified position, such as one single stock, is a huge portion of a person's portfolio. This may arise when a person leaves a company and gets their 401k distribution to rollover. Then prudence would dictate selling a good portion of that position.