Buy-and-Hold and Rebalancing Revised

By Gary Silverman, CFP®

Last week I compared two ways to manage an investment portfolio over time: buy-and-hold and rebalancing. Examples from the Tech Bubble and the Financial Crisis were used. That’s because the bulk of that article was written in the years after those crises. Does the idea of rebalancing, or selling down investments that increased to buy more of the laggards, still make sense?

After all, since then we’ve had a rather strong bull market, only interrupted briefly by the 2020 COVID crunch and the 2022 inflation-triggered selloff. Rebalancing would have hurt your returns. That doesn’t sound smart.

Let’s look back at why rebalancing is recommended. For simplicity’s sake we’ll assume you started with a 50-50 stock-bond mix. If you don’t rebalance and stocks (or a segment of the stock market) outperform the rest of your portfolio, those high-flyers will become a bigger and bigger slice of your investment pie. Assuming market cycles still happen, you are setting yourself up for an even bigger loss than you would have seen when the market does decide to tank.

Let’s say the next bear market results in a 35% drop in stocks. Your original 50-50 portfolio would be down about 17%. If instead your stocks did well across the years, now making up 77% of your portfolio, the resultant loss would be close to 27%. This really should not be a problem because you probably made more letting the stocks ride than you lost when it crashed.

But…

While logic would dictate it’s a bad idea to sell stocks after your portfolio goes down 27%, logic doesn’t always win. When the stock market crashes (or soars) most investors aren’t driven by logic but by emotions (think fear and greed). Allowing your portfolio to keep growing in risk has a good chance of causing a fear-induced sale when things go bad (and they will go bad).

Then there’s getting older. No, I’m not talking about people becoming more risk adverse as they age (though many studies seem to indicate that). But rather the reason you’re investing in the first place, or your investment timeline, keeps getting closer. I’m assuming there was a reason to invest, and most reasons have a timestamp such as retirement or college for the kids.

When markets go down, investments need time to recover back to where they were in the first place. When you are in the middle of your working years, you have plenty of time. But when you have only a few years until retirement or you are there already, you kinda want the cash flow to, well...flow. You don’t want to wait 5 years (or more) for a market recovery.

You then have two choices to keep living in comfort: Sell stocks when they are down, locking in those bear market losses; or sell the safer stuff which makes your portfolio even riskier. Both are doable. But rebalancing can make the problem easier.

The choice is yours.