The Zero-Risk Way To Make Money In 15 Minutes
There are few things I can guarantee with absolute certainty in investing, but this is one of them: Given enough time (usually a year) your portfolio will transform itself into something you never intended.
That’s because the markets almost never move in tandem. According to The Wall Street Journal, international stocks last year averaged 14.5% and precious metals turned in a 16.7% performance. Yet large-cap stocks, measured by the Dow, ended the year down a disappointing -0.61%, and the five- to seven-year U.S. Treasuries offered a mere 1.4%.
And this year, the returns in each asset class will show more even more disparity.
This wreaks havoc with your asset allocation – one of the most important tools for building wealth. It can siphon away the big gains you made last year, and cost you plenty in unrealized profits this year.
Depending on the markets, you could be taking on too much risk, or not enough, which could be just as damaging.
Yet one 15-minute investing strategy can prevent these losses and risks, and also do one other big job: ensure that you consistently “buy low and sell high” – the most direct route to wealth.
This strategy is called rebalancing. And frankly, spending 15 minutes to get your asset allocation back in line isn’t just a good idea… it’s essential.
How to Put Your Profits to Better Use
Sure as the sun will rise, your portfolio will get top-heavy with last year’s winners… That’s when it’s time to take some profits off the table and redistribute them to next year’s winners…
It could be that you’re heavy in international stocks (last year’s winner, but certainly not this year’s), U.S. stocks, high-yield bonds, or precious metals. With the recent correction, if you rebalanced your equities several months ago, you’ve saved quite a bit of money by selling high.
And, of course, that’s when you add the proceeds to last year’s underperforming asset classes, as they have every chance of becoming next year’s sizzlers. This assures you that you’re picking up bargains, or buying low.
Buying low, selling high… Rebalancing actually forces you to do both. And that’s a good thing. Otherwise, you’d continue to buy more of an appreciated asset in the hope that you would be able to sell it at an even higher price in the future. Not a sound practice.
Rebalancing in Action…
So what happens without a rebalancing tune-up?
Let’s say you allocate 60% to stocks and 40% to bonds for a $100,000 portfolio. Let’s then assume that over the next five years stocks earn 15% per year and bonds earn 5% per year.
If you reinvest all your gains and don’t add or withdraw any money (ignoring taxes for the moment), at the end of five years, the stock portion of your portfolio would be worth approximately $121,000. And your bond holdings would be worth approximately $51,000. And your total portfolio value would be $172,000.
Not bad for a five-year period. But before you start celebrating, take a closer look and you’ll notice something else: The portfolio got a whole lot riskier. Why? You started off with 60% in stocks and ended up with 70%.
Although 10% might seem like a small change, consider the implications during the tech bubble. As stock prices soared, many investors’ portfolios swelled with equities. And they were met with even bigger disappointments when the bubble burst.
According to Ibbotson Associates, one of the top financial research firms, rebalancing has the most dramatic risk reduction in market downturns. What that means is simple:
When the markets are performing poorly, your rebalanced portfolio will experience fewer negative returns than a non-rebalanced portfolio. And when the markets finally do make a turn, you’ll have more money to take advantage of the upswing than you would if you didn’t rebalance.
Simply put, rebalancing allows you to get maximum returns for minimal risk.
Three Ways to Pull off the Rebalancing Act
To accomplish the rebalancing act you’ve got three good options:
1. Targeted Rebalancing. For this option, you determine a range of perhaps 5% to 10% around the target allocation for each asset class. If the markets move enough to cause one asset class to exceed the range, you then rebalance to bring them back in line.
2. Tactical Rebalancing. For this, you set broad asset class ranges and incorporate a market outlook into your decisions. For instance, you might set a range for stocks from 50% to 70% of your portfolio. If stocks seem overvalued, you would rebalance back toward the low end of the range. If they seem cheap, you would rebalance toward the high end.
3. Calendar Rebalancing. Perhaps the easiest of all, you simply pick a time period (quarterly, annually, etc.) and rebalance your portfolio back to its original targets.
You can make a case for any of these methods, but we all know the adage of “the simpler the better.” That’s why I favor calendar rebalancing (once every 366 days, to avoid short-term capital gains taxes). It will ensure you actually take the time to rebalance.
In terms of risk-versus-return, there’s no research that’s determined one rebalancing frequency is superior to the rest. The best option would be calendar rebalancing on an annual basis.
And if you’re dealing with taxable accounts, you can avoid or minimize taxes by adding new money to the portfolio and buying the underweight asset classes.
So, pick a date you won’t forget (year-end or perhaps your birthday), and take 15 minutes to add to – and protect – your wealth.