How to Buy Low and Sell High using Simple Rebalancing Technique?
Rebalancing is a simple technique of adjusting % of holdings of various asset classes. Rebalancing is not an one time activity and it should be an on-going process. So we need to maintain the allocation by rebalancing at times.
In simple terms, we go to gym to get fit, shed extra weight. Periodically rebalancing your portfolio is a superb way of staying “in shape” financially. It helps you to shed excess holdings of various assets you hold over and above your risk tolerance.
In order to make a profit on any investment, you must buy low and sell high. Both of these, particularly the former, are extraordinarily difficult to do.
Buying low means doing so when the asset has been falling rapidly with poorer recent returns than other asset classes, generally accompanied by negative commentary from the experts. This is as it should be — you don’t get low prices any other way. Rebalancing in this period will help you to buy low.
Selling high means just the opposite. The asset has had high recent returns and is outperforming other investments; it is the general consensus that it is the “wave of the future.” This is also as it should be — you don’t get very high prices in any other way. Rebalancing in this period will help you to sell high.
Rebalancing is simple technique which forces you to buy low and sell high. It takes many years and many cycles of rebalancing before you realize that it is a profitable activity.
Another way of putting this is that rebalancing forces you to be a contrarian — someone who does the opposite of what everyone else is doing.
Financial contrarians tend to be wealthier than folks who like to simply follow the crowd. This concept also reveals the major benefit of a diversified portfolio: the advantage of “making small bets with dry powder.”
If you have a properly diversified portfolio, you are in effect making many small bets, none of which should ruin you if they go bad. That’s how you win the long game of investing.
It is often said that the small investor is at an unfair disadvantage to the professional, because of the latter’s superior information and trading ability. This is certainly true of trading in individual stocks. It is even more true in the trading of futures and options, where more than 80% of small investors lose money. But when it comes to investing in entire asset classes, it is really the small investor who possesses an unfair advantage.
Why? you have only your own gut reactions to worry about. The mf manager, on the other hand, constantly has to worry about the emotions of clients, who likely will be annoyed with the purchase of poorly performing assets. In such a situation, rebalancing into a poorly performing asset may be an impossibility. They will be questioned if they invest in stocks when market is falling, which is in fact the right thing to do. Successful investing is like driving the wrong way up a one-way street. This is difficult enough with your own vehicle, but nearly impossible when you are doing it in a borrowed Rolls Royce, whose owner is in the back seat, screaming at you at every potential collision.
How Often you should rebalance?
The question of how often to rebalance is one of the common ones in investing. Most people go for quarterly or half-yearly rebalancing, which is too frequent. I would say, once in a year or even 2 years is fine. Other option is to go for tactical asset allocation. With tactical asset allocation, we can rebalance If any asset class deviates the asset allocation by certain %. But please do consider taxation in mind while rebalancing. If it is done properly by combining it with tax harvesting, we can in fact reduce the taxes greatly.
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