It’s natural to wonder where the markets are headed this year, especially after what was a pretty grim end to 2018.
I understand the desire, but the simple truth is we have no idea what’s going to happen and neither do the army of market forecasters we see in the media every day.
But that doesn’t mean we are powerless in the face of market gyrations. We just have to make sure we react to them in a smart, disciplined way.
Unfortunately, that’s not easy. The urge to flee from falling markets is strong and many investors succumb to it. That’s why so many earn sub-par investment returns. Driven by emotion, they jump in and out of markets in a futile attempt to ride the upswings and avoid the downswings.
“The stomach takes over from the head…and stomachs do not make good decisions,” writes author Larry Swedroe in his book Think, Act and Invest Like Warren Buffett.
At PWL, every client has a plan that goes a long way to making sure the head wins over the stomach. It’s called a personal investment policy statement (IPS) and an important part of our job as advisors is helping clients stay on track with theirs.
An IPS establishes how much risk you’re willing to take in your portfolio by setting out your target asset allocations. For example, what percentage should be invested in stocks versus fixed-income and how much should go into sub-asset classes such as Canadian, U.S. and international stocks.
Buffett, the world’s greatest investor, has observed how odd it is that most investors are happy to buy stocks when prices are rising, but run away when they’re falling. That’s the opposite of how they act in other parts of their lives where they’re anxious to buy when the merchandise is on sale.
Logically, one should want to buy stocks at lower prices too and then reap the benefits during the next market advance. But how do you overcome your fear to actually do it? Fortunately, there is a sound, proven way to do this, and it’s called portfolio rebalancing.
As markets move up or down, the composition of your portfolio naturally strays from the asset allocation you’ve set out in your IPS. If, for example, stock markets fall substantially, the equity portion of your portfolio will fall below your targeted percentage allocation. To rebalance, we would purchase stocks—at the lower prices—to restore the target portfolio composition.
A study by PWL Research Director Raymond Kerzého found that “a portfolio based on a widely diversified mix of asset classes, using a variety of different rebalancing strategies (e.g. rebalance every year, every second year, every time an asset class becomes misbalanced by 3%, etc.), provides higher returns (0.50% on average) and significantly lower risk.”
At PWL, we continuously monitor client investments and asset mix. We look to rebalance at strategic times, all the while keeping fees low and looking for tax-loss harvesting opportunities.
Rebalancing is the intelligent way to buy low and sell high. It’s also a great way to stay disciplined regardless of what’s happening from day to day in the markets.