Re-Balancing
During times of market turbulence, it is tempting to seek safety and comfort. This is often done in one of two ways: (1) through selling risky assets for safer assets (think selling stocks for treasuries) and (2) through rebalancing.
Selling risky assets and purchasing safer assets after a market drop is never a good idea. It is either an emotional reaction or the result of a need for liquidity. In either case, the reaction is the result of a portfolio that was too risky to begin with.
The second reaction is often the correct one. By rebalancing, investors can allocate more capital to segments that have recently declined more. The idea rebalancing increases diversification and can increase returns. It can increase returns because segments that have recently declined are more likely to be undervalued.
In today’s market, financial advisors are recommending investors allocate more capital to real estate, cyclical firms, and international firms due to recent underperformance. However, the recent underperformance comes on the heels of many years of spectacular performance. The recent underperformers are still overvalued.
While I encourage people to re-balance their portfolio periodically, the current recommendations are misplaced due to the fact that many of the securities recommended are still grossly overvalued.
