In my last blog post, I mentioned that I had recently set up a passive portfolio comprising 70% stocks and 30% bonds. You might wonder whether it is the worst time to invest, considering that the Dow Jones Industrial Average (DJIA) is near an all-time high while the Federal Reserves is planning to raise interest rates from an all-time low. Any fall in the DJIA will lead to losses on the stock component of the portfolio while any rise in interest rates will lead to losses on the bond component. While I do not welcome a crash in stock and/or bond prices, I am nevertheless comforted by the fact that there is a defence mechanism inherent in the portfolio, namely, portfolio rebalancing. When stock and/or bond prices undergo large changes, portfolio rebalancing will take advantage of such volatility and eventually lead to higher portfolio value. See the post on Volatility is Your Friend for more info.
Likewise, my other portfolios besides the passive portfolio mentioned above have defence mechanisms in place. My Supplementary Retirement Scheme (SRS) portfolio is based on Dollar Cost Averaging. Regardless of the price level of the unit trusts, a constant sum of money is invested in the portfolio every month. When prices are low, more units will be bought in, therefore reducing the average cost of the units. This defence mechanism has been tested and proven to work during the Global Financial Crisis in 2008. See the post on Dollar Cost Averaging Works Best with Volatile Stocks/ Unit Trusts for more info.
As for my active portfolio, it comprises preference shares and cash besides stocks and REITs. When the market crash comes, the preference shares will be liquidated and reinvested into beaten down stocks and REITs. Interestingly, this market timing strategy is also a form of portfolio rebalancing, except that it does not aim to maintain the same portfolio allocation throughout the market cycles. In fact, it is a more aggressive form of portfolio rebalancing, with the allocation to stocks increasing as the price of stocks gets lower and decreasing as the price of stocks gets higher.
Of course, investing at the wrong time brings a lot of losses and heartaches. However, very few people can predict correctly where the market will move. Instead of waiting for the right time to invest, why not have the right strategy to invest with? Who knows, even when you have waited for the right time to invest, i.e. at the market bottom, you might not recognise that this is bottom or have the courage to invest.
There is a Chinese saying "运筹帷幄之中，决胜千里之外". If you plan your strategies properly, you could decide the outcome of a battle a thousand miles away. In investing, the equivalent concept is that the outcome of a battle is decided a thousand days away, before the market crash begins.
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wonder if active stocks will always have to be liquidated in a crash. if your strategy is sound you should see a crash. what is a crash?ReplyDelete
No, good stocks need not be liquidated. A crash is an opportunity to accumulate more good stocks and make more money.
Hi Chin WaiReplyDelete
I have a busy work schedule. Is there any way to actively rebalance portfolio by spending minimal time and effort?
The beauty of portfolio rebalancing is that you don't have to constantly check how the portfolio is doing. You just have to occasionally check whether the portfolio allocation has deviated from the original allocation by a large margin and rebalance if it does. You can refer to my other post "Portfolio Rebalancing - A Fine Balancing Act" for more details.
(The) Boring Investor