Buy –and-Hold and Rebalancing Are Viable Investment Strategies

There are many ways to invest your money. There are different investment types, different ways to invest in those types, different strategies for managing the investments, and different tactics for moving things around. I’m going to consider two viable ways to handle your investments: buy-and-hold and rebalancing.

Buy-and-hold is pretty self-explanatory. You buy an investment and you keep it until you need to turn it into cash to spend. This is a lazy person’s dream. It also works out pretty well. After all, if you don’t do anything in-between buying and selling, it’s hard to make many mistakes.

While we could nitpick the buy-and-hold strategy to bits, there are really two main problems with it. The first one is that companies change, and many don’t last 30 years. This is rather easily solved. Instead of investing in individual companies, you invest in mutual funds. That way you get a mix of securities in one nice wrapper and if something needs to be replaced, someone else does it for you.

The other problem with buy-and-hold is that the portfolio can get out of balance. For example, let’s say you put half of your money in a mutual fund that invests in stocks and it earns an average of 10% a year. You put the other half of your money in a mutual fund that invests in bonds and it earns 6% a year. So at the start you have a 50-50 stock-bond split.

Thirty years go by. You’re now approaching retirement. Looking at your portfolio, you find that you have less than a quarter of your money in bonds. Your 50-50 split became 77-23…stocks are now over three-quarters of your portfolio. Over the years stocks grew more than bonds, so your portfolio got riskier—exactly the opposite of what most retirees want.

Rebalancing, well, rebalances things. You might rebalance once a year, once a quarter, or even every day. Rebalancing gets rid of the biggest problem that buy-and-hold has:  your portfolio getting unbalanced. In the previous example, the portfolio would have been driven back to its original 50-50 split by rebalancing.

However, there is a psychological problem with rebalancing. If you were rebalancing once a year back in the late ‘90s you would have been selling off stocks during a bull market. Many people in that position would say to themselves, “Self, why would I want to sell down my stocks which are doing well and buy bonds with the proceeds?  I should sell some bonds and buy stocks with the money.”

Or, if you rebalanced at the start of every year, in 2009, you would have just experienced half of your stock holdings getting wiped out. How likely are you to sell off some of your nice, safe bonds and buy some of those evil risky stocks? If you’re normal, not likely at all.

There are many variations to this theme, each promising to fix the problems in either strategy. But I’ve outlined the main differences and problems that I’ve noted most people have with them. With either, you can be successful.  Just don’t think either one is problem-free.

This article was published under the title "Investing strategies will carry some risk" in the Wichita Falls Times Record News on October 16, 2011.