The market rarely rings a bell when it’s time to buy or sell. The time to buy is often the time when people are most afraid. The time to sell is often when people are most optimistic about the market. This was true in 2000 and 2009.
Rather than trying to guess or consult your crystal ball, portfolio rebalancing lets your portfolio tell you when to sell and when to buy.
You begin by creating a diversified portfolio that reflects your risk tolerance. A “moderate” investor, neither too aggressive or too conservative, may have a portfolio that contains 40 – 60% stocks and a corresponding ratio of bonds.
Checking your portfolio periodically will tell you when you begin to deviate from your chosen asset allocation. During “bull” markets your stock portfolio will begin to grow out of the range you have set for it, triggering a need to rebalance back to your preferred allocation by selling from the stock portfolio and using the proceeds to buy more bonds. During “bear” markets your bond portfolio will grow out of its range. Rebalancing at this point will cause you to add to the stock portion of your portfolio, even as emotion is probably urging you in the opposite direction.
If properly implemented and regularly applied, this will allow you to do what every old Wall Street sage will tell you is the way to make money in investing: “Buy Low and Sell High.”