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Rebalancing in a down market
The emotional aspect of investing often makes it difficult to shave allocations in securities that have recently performed well
and reallocate it to securities that have not performed as well. This reluctance is especially strong in times of market crisis,
such as what we experienced in 2008. That year, stocks lost 37.00%, while bonds gained 5.25%. In such a time of instability
and uncertainty, many investors sold all of their risky assets and removed themselves from the market altogether. This is an
example of a time when it is most critical for you to remember your long-term strategy when saving for retirement. For example,
if you had stayed in the market throughout 2008, your portfolio would have generally recouped your losses in the next two
calendar years. You also would have benefited from the positive performance in the years that followed.
We have discussed the importance of rebalancing after a market rally, but it is equally important to rebalance after a market
downturn. The following table shows a scenario of what might have happened to a hypothetical portfolio in 2008:
Asset Class
Beginning Balance
Proportion
2008 Market
Return
Ending Balance
Ending Proportion
Stocks
$5,000.00
50.00%
-37.00%
(1)
$3,150.00
37.45%
Bonds
$5,000.00
50.00%
5.24%
(2)
$5,262.00
62.55%
Total
$10,000.00
$8,412.00
(1) Three-year average based on S&P 500 Index
(2) Three-year average based on Barclays U.S. Aggregate Bond Index
Asset Class
Beginning Balance
Proportion
Desired Proportion
Buy / (Sell)
Ending Balance
Stocks
$3,150.00
37.45%
50.00%
$1,056.00
$4,206.00
Bonds
$5,262.00
62.55%
50.00%
-$1,056.00
$4,206.00
Total
$8,412.00
$8,412.00
Rebalancing this portfolio during a down market would require the following transactions:
As an investor, you may have been hesitant to rebalance in a down market, especially when it would have required you to buy
more stocks after the equity market just experienced a -37.00% return. However, rebalancing would have benefited you greatly,
as stocks returned 26.46% and 15.06% over the next two calendar years. The portfolio above would have experienced the
following returns had you rebalanced the portfolio at the end of 2008.
Asset Class
Beginning Balance
Proportion
Combined Return for
2009 & 2010
Ending Balance
Stocks
$4,206.00
50.00%
45.50%
$6,119.73
Bonds
$4,206.00
50.00%
12.90%
$4,748.57
Total
$8,412.00
$10,868.30
As depicted above, the portfolio recouped all of the losses
experienced in 2008 by 2010 because of the rebalance.
The above table shows that rebalancing is based on a
“buy low, sell high” mentality. The trimming of the best
performing assets in the portfolio aligns with the theory
of selling high and locking in the investment gains. On the
other hand, buying the lower-performing assets fulfills the
“buy low” mentality.
Most 401(k) and 403(b) plans do not carry transaction
costs, so buying and selling investment options should
not cause you to incur additional expense. Your plan
provider also may offer an automatic rebalance feature. We
strongly encourage participants to take advantage of this
tool. An automatic rebalance feature periodically buys and
sells investments in your account based on your desired
allocation between stocks and bonds. The frequency of the
automatic rebalance can vary. Typical time periods offered
are: quarterly, semi-annually, or annually. We recommend you
rebalance your portfolio at least annually.
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