A Dangerous Moment

Jonathan Clements

MY PORTFOLIO HAS bounced back nicely from October 2022’s stock market low—and that’s a problem: I’ve learned over the decades that I’m not good at handling prosperity.

At issue is the question of when to rebalance my portfolio, in this case selling stocks and buying bonds to bring them back into line with my target percentages. Among experts, there’s no agreed-upon strategy, which is almost an invitation to bad behavior. We investors do better with hard-and-fast rules.

Some folks rebalance according to the calendar, such as every quarter or every year. Others rebalance when their portfolio strays by some specified amount from their target percentages, such as when their stocks go from a desired 60% of their total investment mix to either 50% or 70%.

And then there are those who—to use a technical phrase—are a little loosey-goosey about the whole thing. That’s the camp I’m in, for two reasons. First, history tells us that, at both bear market bottoms and bull market peaks, stocks can become unmoored from their fundamental value, though often this is only apparent in retrospect. Second, both on the way down and during the initial market recovery, stock prices often display momentum, thanks to a bandwagon effect as latecomers pile on the selling or buying pressure.

What does this have to do with rebalancing? When share prices fall steeply, I tend to “over-rebalance” into stocks, a strategy I described last October. This isn’t about forecasting what the stock market will do, but rather reacting to what it’s done—dropped to the point where there’s a possibility that stocks are below their fundamental value. I used over-rebalancing to good effect in 2008-09, 2020 and last year. I love buying when share prices are down sharply.

Meanwhile, when stocks start to rebound, my head tells me to hold off rebalancing back into bonds for a year or two, and instead ride the stock market’s upward price momentum. But, alas, I find this hard to do. Indeed, when I look at my own investing behavior, I see two related faults—traits I’ve tried to overcome, but with only partial success.

First, when the stock market starts to bounce back, I struggle to keep buying, even though the prices on offer may be below those at which I was merrily shoveling money into the market during the preceding decline. What’s going on here? Early in a market recovery, some folks no doubt think stocks will fall back and they’ll get another chance to buy at lower prices. But for me, a different instinct is at work—a reluctance to buy when I know better prices were available just a few days or weeks earlier.

Second, I tend to sell too early in market rallies. In other words, it isn’t just that I grow increasingly reluctant to buy as share prices bounce back. That reluctance to buy often turns to selling. For instance, during the recovery from the 2007-09 stock market collapse, I started lightening up on stocks far too soon. Admittedly, I’d gone out on a limb in late 2008 and early 2009, over-rebalancing so stocks had ballooned to some 95% of my portfolio. Still, if I’d sat tight for longer before cutting back my stock exposure, my portfolio’s performance would clearly have been better.

My hunch: I’m partly influenced by the old “get even, then get out” phenomenon. By 2010, having recouped much of my losses, I didn’t want to risk another big hit, so I pared back my stocks. To be sure, my selling wasn’t too extreme. Through the bull market of the 2010s, I kept 70% to 80% of my money in stocks—but it’s also clear I lightened up on stocks too early.

When will I start selling this time around? Partly, it’ll depend on the stock market. I assume the fitful market recovery, up almost 22% since mid-October as measured by the S&P 500, will continue as inflation eases and the Federal Reserve brings its rate-hiking campaign to an end. But I could be wrong, in which case I’ll sit tight with my overweight position in stocks for longer.

Before 2022’s bear market, I had more than 20% of my total portfolio in short-term bonds in preparation for my eventual retirement. That 20% would have given me roughly five years of potential spending money, assuming a 4% withdrawal rate. Today, I’m at around three years of potential spending money, thanks to my 2022 stock-market buying. I’d like to get back to five years’ worth.

If the stock market continues to recover, maybe I’ll do at least a little selling later in 2023, once we’re a year into the rebound. But I haven’t got a firm timetable laid out. Like I said before, it’s all a little loosey-goosey—and I worry I’ll once again find myself selling a tad too soon.

What’s the best strategy for rebalancing a portfolio? Offer your thoughts in HumbleDollar’s Voices section.

Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.

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