The Rules, Part XXVIII

Rebalancing of any sort in investing presumes an underlying stability to the economic system, and thus, market returns.? Rebalancing will not protect against socialism, war, or an overleveraged position.

The concept of rebalancing requires the idea of reversion to mean.? It will not protect you when profound shifts are happening, where the market are moving to a new equilibrium different from the old one.

Many shifts in the markets are precipitous; they don’t allow for slow adjustment.? That’s why many lose out when sharp shifts occur.? Especially in leveraged positions, the question comes: “Do I take my loss, invest more, or just let it ride?”

The best answer is forward-looking, only asking what is most likely.? The best preparation is also forward-looking, but with a glance to the past, asking what could happen at worst, which is worse than the worst of the past.

There are times when it seems that stability is no more, or that the boundaries for stability are far larger than normal, such as now.?? At such a time, it may pay to follow market trends, realizing that there many participants like you that are struggling to figure out the situation that everyone is in.

The point is to be forward-looking.? Ignore the past.? Ask what is most promising over your favored time-horizon.

So when it makes sense, add to a position that has lost money.? When it doesn’t make sense, sell the whole position and realize the loss.? Could this be simpler?

4 thoughts on “The Rules, Part XXVIII

  1. Hey David how often should you rebalance, monthl, quarterly etc. Or should you rebalance when a 60/40 stock bond portfolio gets skewed by 5%, 7% etc. Thanks

  2. David, this is to say, rebalancing works when you know the future. Right. Duh.

    Rebalancing *always* means catching a falling knife. It could have you buying IBM at 50–good trade. Or buying Kodak at 20–not so much. I could have you buying long bonds when they yield 5%, and you feel like a genius. But you might be buying XLF at 25, and still be under water.

    Rebalancing works, but it can take a long time to work. And if you do it too frequently, you’re converting principal into commissions.

    1. Doug, you are right. Duh. What this is meant to point out is that it is not always good to rebalance. It’s a useful tool, but one that must be thoughtfully used, asking, “Is this a good time to do it, or are there conditions that do not favor it?”

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