The investment management concept of rebalancing can be found everywhere in the financial media. Most financial advisors can talk for several minutes, uninterrupted, about the merits of rebalancing.
The recent stock market decline has coincided with the end of 2015 and the beginning of 2016. End-of-the-year reviews are promoted as the perfect time to rebalance. The company 401(k) retirement plan rebalancing drum beat has been deafening.
Rebalancing means that on a predetermined date, you reset the asset allocation mix of stocks, bonds back to a previously determined level.
You can rebalance on any day that you can remember–like your birthday, your wedding anniversary, or the day that you adopted your dog from the local animal shelter.
Your ideal rebalance level is determined by a risk tolerance questionnaire. You know about risk tolerance questions, right? Those are the computer-generated questions from your company 401(k) retirement plan provider or your current financial advisor.
These questions are supposed to determine “how much risk you can take” with your company 401(k) retirement plan account investments.
Let’s say that the asset allocation software program calls for your company 401(k) retirement plan account to own 70 percent stocks and 30 percent bonds at all times.
The recent January 2016 stock market decline would have surely notified you to maintain your 70% stock market exposure. So the common sense question is, “Why would you have continued to hold 70% of your company retirement plan account value in U.S. stocks during a declining stock market environment?
Your company 401(k) retirement plan account rebalancing mandate would have encouraged you to sell off the investments that are providing positive investment returns (bonds) and buy more of the investments that continue to lose money (stocks).
Worse, your pie chart asset allocation would have urged you to continue to buy stock market mutual funds with the new money that you contribute every month to your company retirement plan account.
Does the phrase “throwing good money after bad” ring a bell for you?
Following the pie chart and rebalancing investment management behavior in most cases produces the exact opposite of what common sense would dictate you to do.
If you get poor service at a restaurant, do you “rebalance” your dining experience by revisiting the same restaurant several more times in the hope that at some future point, the service will improve?
Common sense dictates that you don’t put yourself through another customer service experience all over again. Rebalancing using a pie chart suggests that you do.
Do you put yourself through another declining stock market environment just because a computer told you to?
Rebalancing reminds me of the old joke about the guy who has a severe headache. One day he can’t take the pain anymore so he visits the doctor. The doctor asks him how he thinks he got the headache. The guy says that he constantly hits his head against the wall.
The doctor says, “Why don’t you stop hitting your head against the wall?” The guy goes home and stops hitting his head against the wall. Miraculously his headaches suddenly stop.
Rebalancing is periodically selling off the good investments you already own, taking the proceeds, and then buying more of the bad investments that you already own. All done in the hope that the bad investments you own will “get better” sometime soon.
The rebalancing investment management behavior is promoted by the financial media and the majority of investment advisors. At the core of this investment management strategy are the answers to risk management questions that you did not understand in the first place.
There is nowhere else in your life where rebalancing makes sense. Rebalancing also makes no sense in your company 401(k) retirement plan account.
Ric Lager
Lager & Company, Inc.
