When it comes to investments, there seems to be a lot of “conventional wisdom.”
We have heard that we should rebalance our investment portfolio periodically. That means if you have 30 percent in bonds, 10 percent in precious metals and 60 percent in stocks, periodically you sell some in a category whose proportion is greater than it was the last time you rebalanced and buy some in the categories that have shrunk proportionally. But does it make sense to sell some of the assets in a class that has performed well to purchase more assets in a class that has performed poorly? In other words, conventional wisdom tells me to sell some of my winners to buy more of my losers. That doesn’t make sense to me.
I must make a disclaimer here: My wife, Diane, handles all our investments, and she does an excellent job of it. We have two rules. One is that she is not to listen to me when it comes to investment matters. That rule saved us a bunch during the recent market turmoil. The second rule is “too many cooks spoil the broth.” More on that later.
So where did the “rebalance your portfolio” concept come from? I don’t know, but let’s think of who would benefit from your rebalancing your portfolio. One who would benefit would be the investor who is selling some of her losers to buy more winners. That person might just be your investment advisor, or the market leaders in general.
I hear from some investment experts that stock A is undervalued by the market, so you should buy more of it. Wait a minute. What happened to the efficient market hypotheses (EMH)? That theory that states: “It is impossible to ‘beat the market’ because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.1” Did the EMH get repealed? Does the speaker have some insider information, which is illegal to use in purchasing or selling equities?
I have a different take on the EMH. First, not everyone gets the information at the same time. That was a bigger issue before the internet was so ubiquitous. Brokerage houses, investment banks, private equities firms and hedge funds spend millions, perhaps even billions, of dollars trying to develop and maintain computerized trading to be one nanosecond ahead of the other brokerage houses, investment banks and private equity firms with their trading. They know if they are first to the exchange with information that reflects a change in the value of an equity, they win.
So where did the “rebalance your portfolio” concept come from? I don’t know, but let’s think of who would benefit from your rebalancing your portfolio.
Secondly, two different investors might view the same information as having opposite effects on the value of a stock. Even if the two agree as to the direction the stock will go, they might not agree on the magnitude. Not all the information is available to everyone, and not at the same time. Sometimes the news is erroneous, and sometimes the recipient has a bias towards the source of the information itself.
Another rule of thumb is that “if you cannot buy a lot of different stocks, buy into a fund and let a professional manage your money.” Sounds good, but then who is really making the money? Likely the fund manager, who gets a bonus if he makes money but doesn’t give it back when he loses your money, even though you get the brunt of both gains and losses. And the fund manager doesn’t work for free, no matter how the prospectus is worded.
My second rule of investing is that “too many cooks spoil the broth.” Translation: One person’s successful investment strategy will get diluted, and thus become less effective, if the advice of another is added to the decision process.
I have also heard “You should invest your age in bonds.” This one is like the “periodically rebalance your portfolio,” but with a twist. You rebalance towards fixed income instruments, like bonds, as you age. But there can be a problem when interest rates change, as they do: Bond values rise or fall. If you need the money that you have in a 2 percent, 20-year bond and interest rates have increased to 3 percent, you will take a big loss if you sell the bond with interest rates 50 percent higher than the bond’s coupon rate. And it is likely that interest rates went from 2 percent to 3 percent because inflation went up proportionally, meaning your cost of living went up as well.
My second rule of investing is that “too many cooks spoil the broth.” Translation: One person’s successful investment strategy will get diluted, and thus become less effective, if the advice of another is added to the decision process. That does not mean that the investor shouldn’t get as much knowledge and advice as she can, but the investor needs to weigh it all according to her individual investment objectives, risk tolerances and time horizon. That includes knowledge and advice from investment advisors, television pundits and co-workers. I believe that if two or more very successful investors band together to manage a pool of assets, they will generate an outcome that is suboptimal to what either could do alone unless they all have exactly the same strategy, purpose, investment horizon, view of risk and transaction propensity.
“Invest in a basket of equities” is another oft-heard phrase. This encourages individuals to invest in companies and industries about which they have no expertise, let alone knowledge. We know what happens when you spread such risk — the losers will be offset by the winners. That works great in insurance, even though we have the underwriting and selection process to try to keep us from insuring losers, but that’s a different story. (Or is it?) Again, brokers who want you to “have a balanced portfolio” and “spread your investments in a variety of market segments” might have a different (sales commission) motive in mind.
When it comes to investing, conventional wisdom can be controversial.