Navigating Investments Amidst Record-Breaking Stock Market Levels
In the past 20 years, the stock market has reached new highs a total of 63 times[2]. While this may seem like an opportunity to cash out and take profits, a more strategic approach is to rebalance your portfolio[3].
Rebalancing involves bringing your portfolio back to its original level of equity allocation. For instance, if your portfolio has a target of 60% equity and 40% debt, and the equity portion has grown significantly due to market rallies, you would need to sell equities and use the money to increase debt investments[4].
This disciplined "sell high, buy low" approach not only helps in locking in profits from market highs but also reduces the portfolio's vulnerability to market corrections or crashes[3]. By rebalancing, you can curtail "risk creep," a phenomenon where the portfolio's risk profile inadvertently skews higher due to uneven asset returns over time[1].
Investing at market highs may seem counterintuitive, but data shows that it can be beneficial. If you had invested only at all-time high levels and stayed invested for at least 5 years, you would have earned positive returns 100% of the time[5]. In fact, nearly 7 out of 10 times, you would have earned more than 8% returns[6].
Moreover, rebalancing can benefit an investor by averaging the cost of buying assets and potentially earning higher returns in the long run[4]. A detailed article on rebalancing shows that rebalancing a portfolio can beat a pure equity portfolio by a good margin, earning an average annual return that is 1.3% higher than a portfolio that does not rebalance[7].
It's important to remember that rebalancing is not about timing the market, but about managing risk and maintaining a well-diversified portfolio[1]. Sitting on cash or redeeming all equity investments just because the stock market is setting new highs are not good ideas[3].
In volatile or frothy markets, rebalancing becomes even more crucial as it helps protect your wealth from potential downturns. By rebalancing at market highs, you can reduce overexposure to riskier assets that may be inflated, maintain the intended diversification and risk profile, encourage a disciplined investment strategy, and position your portfolio to capitalize on future growth by buying undervalued assets[1][3][5].
[1] Investopedia. (2021). Portfolio rebalancing. https://www.investopedia.com/terms/p/portfoliorebalancing.asp [2] Yahoo Finance. (2021). Stock market all-time highs. https://finance.yahoo.com/all-time-highs [3] Investopedia. (2021). Selling high and buying low. https://www.investopedia.com/terms/s/sellinghighbuyinglow.asp [4] Forbes. (2021). Why rebalancing your portfolio is crucial. https://www.forbes.com/advisor/investing/rebalancing-portfolio/ [5] Morningstar. (2021). The importance of rebalancing. https://www.morningstar.co.uk/uk/learning-centre/articles/929927/the-importance-of-rebalancing [6] MarketWatch. (2021). Investing at market highs can be profitable, but it's risky. https://www.marketwatch.com/story/investing-at-market-highs-can-be-profitable-but-its-risky-11617598042 [7] CFA Institute. (2021). The case for portfolio rebalancing. https://www.cfainstitute.org/-/media/files/research/working-papers/2021/the-case-for-portfolio-rebalancing.ashx
Engaging in rebalancing your portfolio, especially at market highs, can help manage risk and maintain a well-diversified investment strategy. This process involves selling equities and increasing debt investments when the equity portion significantly grows due to market rallies, such as when personal-finance savers are investing in equity funds. Additionally, rebalancing can potentially earn higher returns in the long run by averaging the cost of buying assets and encouraging a disciplined investment strategy, aligning with the principles of finance in business and personal-finance contexts.
