Buy low sell high, that’s the mantra of Wall Street (actually, it’s probably “Buy low very often, sell high very often,” but I digress), and one that you can achieve every single time you rebalance your portfolio. Rebalancing your portfolio is a task that no one likes to do because it’s so mechanical, it’s so unsexy, but it’s so necessary and one that can guarantee that you’ll be buying low and selling high. How is this guaranteed?
Rebalancing is the act of adjusting your portfolio such that the asset allocation is shifted back to your target asset allocation. Throughout the year, your various assets will rise and fall in market value, resulting in a shift of allocation. If stocks performed better than your other asset classes, they will comprise a greater percentage of your portfolio. If you had a conservative mix of 50% stocks and 50% bonds and stocks rose 10% while bonds rose only 5%, you now have 51.16% stocks and 48.84% bonds. In rebalancing, you’d be bringing both assets back to 50% by selling some stocks and buying more bonds.
How does this guarantee buying low and selling high? If your asset allocation remains the same, you will be selling the better performers for the weaker performers. In the above example, if stocks had fallen relative to bonds, you’d be selling bonds to buy more stock. As you saw above, both can appreciate and you would shift from the better performing asset to the weaker asset.
What if you’re worried about selling a shooting star midway in its path? Well, there’s always the risk of that but since you’re only rebalancing once a year (or twice), the other benefits outweigh the possibility of that happening. Also, consider yourself banking some of the earning all the way up. Plenty of dot com folks watched shooting stars fly… and then crash, with nothing to show for it.