I wrote this article on February 11th, 2012 for my Golden Valley Patch Blog.
The investment management concept of rebalancing can be found everywhere in the financial media. If you ask a financial advisor about the subject, he or she can talk for several minutes, uninterrupted, about the merits of a rebalancing “investment strategy.”
Rebalancing your 401(k) account means that on a predetermined date, you reset the asset allocation mix of stocks, bonds and money market investments 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 of the annual Golden Valley brush pickup.
The rebalance level set for you is determined by a risk tolerance questionnaire. Your answers to a set of computer-generated questions are intended to guide your stock and bond markets investments through up and down stock market cycles.
You know about risk tolerance questions, don’t you? Those are the series of questions that you answer online at your company retirement plan provider or through your current financial advisor. These questions are supposed to determine “how much risk you need to take” with your company retirement plan account investments.
Let’s say that based on your answers to those questions, the asset allocation software program in your company retirement plan account called for you to own 70 percent stocks and 30 percent bonds over the last three years.
There is no way on earth you have made a positive investment return owning any broad mixture of U.S. stocks over the last three years. So, the value of your stock market mutual funds would have surely dipped below the predetermined level of 70 percent of the total value of your 401(k) account.
Your computer rebalancing notifications would have urged you to maintain your 70 percent stock market exposure anyway. So the common sense question is, “Why would you have continued to hold 70 percent of your company retirement plan account value in U.S. stocks during a declining stock market environment?”
Your account rebalancing mandate would have encouraged you to repeatedly sell off the investments that did well over the last three years (bonds) and continue to buy more of the investments that continued to lose money over the last three years (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 contributed to your company retirement plan account over the same time period.
Does the common sense phrase “throwing good money after bad” ring a bell for you?
No. How about this one? “Sell low and buy high.”
In following the pie chart and rebalancing your company retirement plan account over the last few years, your investment management behavior would have been the exact opposite of what common sense would have dictated you to do.
If you get poor service at a restaurant, do you “rebalance” your dining experience there by going back several more times in the hope that at some future point, the service will improve?
How about where you get your car fixed? Or one of your doctor visits? Do you go back and endure the poor customer service experience all over again?
Would you put yourself through another bad investment experience just because a computer told you to?
Rebalancing reminds me of the old joke about the guy who constantly bangs his head against a wall. 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, stops hitting his head against the wall, and his headaches suddenly stop.
Rebalancing is periodically selling off the good investments you already own, in the hope that the bad investments you already will “get better,” sometime soon. And you engage in this behavior because a computer told you to, based on your answers to questions that you did not understand in the first place.
There is nowhere else in your life where rebalancing makes sense. Rebalancing makes no sense in investment management either.
Ric Lager
Lager & Company, Inc.
