Few people specifically know how well their portfolios have done over the past decade.
And most investors probably overstate their true profits. I may be among the majority who doesn’t know his portfolio’s exact performance. But I can make a decent guess.
I’d peg it at roughly 11.6 percent per year, or 200 percent overall, from May 2002 to May 2012.
During this time period, my investment club earned exactly 8.9 percent annually on a full stock portfolio (measured by the club tracking software at www.bivio.com) but I had a secret weapon in my personal account, allowing me to run circles around my investment club’s returns: my bonds.
On May 2nd 2012, I added a further $120,000 of bonds to my portfolio.
I’ll explain why and how below.
Bonds? Yeah, they’re about as exciting as a runny nose. You say the returns on bonds are currently awful? Perhaps they are. But I don’t buy them for their interest yields. I covet them for their dry powder appeal.
Dispassionately rebalanced bonds and stocks can reap generous results, especially when the stock market’s chart looks like a series of peaks and canyons.
Take a look at the decade long S&P 500 chart below. Generally, stocks and bonds move in opposite directions. Not always, but usually. What if you bought bonds when the stock market was rising? And what if you bought stocks when the stock markets were falling? You would have been zigging when most people zag—and you would have earned enviable returns in the process.
What’s more, it wouldn’t have required any kind of special forecasting or market timing.
I wrote about this rebalancing process in my book, Millionaire Teacher.
To boil it down as simply as possible, when stocks rise, I buy bonds. When stocks fall, I buy stocks.
As a recipe for success (especially during volatile stock markets) it’s a phenomenally profitable practice.
To be clear, it doesn’t involve selling all of your stock investments when they rise, and buying them back when they fall. That’s called market timing—and the side effects eventually hurt for nearly everyone who decides to play.
My process is less painful, and far less risky:
I keep my portfolio somewhat balanced between stocks and bonds, with (currently) 40 percent in bonds and 60 percent in stocks. When stocks fall, to keep my 60 percent allocation, I add fresh money to my stock indexes. When stocks rise, I add to my bond allocation, to keep the portfolio split 60/40.
When the markets exhibit manic depressive behaviours, as they did in 2003, 2008/2009, June 2010, August/September 2011 and April 2012, then I’m forced to rebalance by selling some of my “winners” to buy some of my “losers”. All I’m trying to do is keep my portfolio as close to my target allocation as possible.
If you’re questioning my claim of making 200 percent in the stock and bond markets over the past decade, consider this: Assetbuilder, a financial service company, rebalances portfolios of indexes for their clients. Three of their model portfolios would have made more than 200 percent over the past decade. These aren’t single funds that I’m singling out. They’re diversified portfolios, rebalanced with regular dispassion.
Unemotional rebalancing is a simple way to make loads of money when the markets are volatile.
But it’s not psychologically easy for people to do. To do so, you must ignore the financial media; ignore economic forecasts; and ignore your natural instincts. Neither of the three is likely to encourage you to do anything useful.
Have a look at the three month chart of the bond index I just poured $120,000 into:
Most investors would hate the looks of a chart like that. But I love it.
Let’s put the chart in perspective by moving to a longer time period: the past six months of the Canadian bond index versus the six month price gain of the S&P 500 index.
The green line represents the bond index. It has fallen slightly while the S&P 500 stock index has gained roughly 13 percent during the same six month time period.
Can you imagine what this did to my portfolio’s allocation? Because of the market’s rise, I found myself with significantly less than a 40 percent bond allocation.
So I sold some of my stock indexes yesterday (mostly the U.S. market) and put $120,000 into my Canadian bond index.
Now I’m much closer to my 60 percent stock, 40 percent bond allocation.
Will such rebalancing always deliver great results?
If the next ten years are as volatile as the previous ten, I think you’ll do very well, if you have the courage to follow the game plan.
During bull markets, however, rebalancing a portfolio could create a minor drag on your returns, relative to what a 100 percent stock allocation would deliver.
But it’s still a prudent method of smoothing out returns, while giving you a wonderful position to take advantage of volatility if the markets have a crazy year, or ten.