Portfolio Rebalancing Lies

The premise:
Rebalancing takes advantage of the buy-low/sell-high principle. During a dramatic drop in stock prices, traditionally, the bond market rises and there are strengths in other sectors such as commodities and international.

Rebalancing purportedly tries to take advantage of situations such as this. When bonds are up, you sell some and buy some stocks that are down. In that way you sell high (the bonds) to buy low (the stocks). And you would do the same regarding other asset classes. When you rebalance, you sell some of the strongest performers in your portfolio and buy some of the underperformers.

Sounds good and it’s a principle that has been and continues to be pushed by many brokerages and their financial advisors. But in reality, you are selling the winners to add to the underperformers. Why wouldn’t anyone want to continue to run with their best performers?

An obsolete formula. Many people who habitually rebalance their portfolios do so to realign them with a shopworn asset allocation that was wrong in the first place. This allocation, calling for too much of the portfolios assets to be devoted to bonds to begin with and far more as investors approach retirement, has been around for decades. Various studies have shown that long-term investors do better by having far more money in stocks than this allocation allows. Having your clients’ money in different types of investments may potentially reduce risk, but it’s crucial to understand the inherent risks vs rewards of one  type of investment versus another over the long term.

Plus, lets face the ultimate truth. Portfolio rebalancing ultimately benefits the advisor/brokerage house as it sacrifices a client’s future gains in strong performing positions to dollar cost average down weak and underperforming portfolio selections. Plus, until recently, it was a convenient way to rack up trading commissions for the house.