If you’re an investor, then you’ve almost certainly heard the term ‘balanced portfolio’. And the expression ‘buy low, sell high’ probably rings a few bells. But have you considered that the two are closely related?
First, a quick explanation of the balanced portfolio concept.
Let’s say you’re a 35yr old project manager, planning to retire at age 60. You’re a fairly aggressive investor, so you’ve chosen an asset allocation plan that includes: 75% equity, 15% bond, 10% money market. You chose to invest the equity portion equally in three mutual funds (A, B, and C), and chose a bond fund (D) and a money market fund (E) for the balance.
You start out with $100,000 (an inheritance from when your grandmother died last year), and invest it as follows:
One year later, equities have done very well, going up 15% on average (your funds have increased as follows: A +10% B +15% C +20%), while bonds have done quite poorly (D -5%). Money Market, as usual, has done slightly better than breaking even (E +2%).
So now your investments from last year are worth:
for a total value of $110,700.
Your natural inclination, when looking at how your investments have done, is to pull everything out of that lousy bond fund and the underperforming money market fund, and put it all into the high-performing equity fund C. It’s clearly far superior to the others.
Now, that would be called selling low, and buying high. And it’s what people do all the time – chasing high returns. Sometimes it works, and sometimes you lose your shirt.
Instead, your investment advisor convinces you to stick with the original plan (a balanced portfolio), and you invest this year’s $20000 (you got a great bonus at work last month) according to plan. Your new balance will be $130,700, and so your breakdown by fund should be:
A $32675 (25% of 130700)
D $19605 (15%)
E $13070 (10%)
So this year, you’ll invest your additional $20000 as follows:
It may look as though you’re investing way too much in that bond fund that did so poorly last year, but that’s what ‘buy low’ is all about. Last year’s underperformer is likely to be this year’s high-performer. Of course, you’ll still want to make sure that you like each of your funds within their asset-type, but the decision between asset-types has been made, and you should stick to it.
If you stick to this until you retire, you’ll consistently buy low, and sell high. Without having to correctly predict where the market is going (let’s face it, how has that been working for you up til now?).
Just something to consider…