The Power of Rebalancing During a Volatile Market

Andrew Hallam -

There’s no doubt that the past decade has seen some volatile stock markets.  And some people (understandably) find that frightening.

But if you create a diversified account of stocks and bonds (or stock and bond indexes) and if you rebalance your account by ensuring that you keep your account’s allocation relatively consistent, then you can make a small fortune during volatile markets.

But to do so takes courage. 

When stocks fall, the media exploits investors’ fears, so for anyone following the news, a falling market could be a terrifying time.  But it shouldn’t be.  A lower stock market is a safer long term investment than a high stock market.  If you’re adding money to the markets, you should feel relief when the markets fall, not fear.

The nice thing about having a blog is that I can make my investment moves public, and then refer back to them.

Let’s look at the previous year or so.

In May/June 2010, the stock markets were lower than they are today.  If you didn’t know that, then you’ve been influenced by the media.  It’s true.  Despite the recent stock market drop, the markets are a lot higher today than they were in June, 2010.

I have an allocation of bonds that’s close to my age:  roughly 40%.

When the markets fell in 2010, my allocation of bonds was higher than 40%, so I had to make an adjustment at the beginning of June.

This is what I wrote from a 2010 post:

Selling off more than $120,000 in bonds, (in June) I bought decent sized positions in:

Here are the prices of those holdings today (August 27, 2011)

  • Coca Cola:  $68.50 (up 41% including dividends)
  • Johnson & Johnson:  $64.28 (up 16% including dividends)
  • XDV.To:  $20  (up 12% including dividends)
  • Microsoft:  $25.25  (up 8% including dividends)

I did eventually sell all of those stocks to buy indexes, but for stock pickers, there might be an additional lesson in this.

When you feel that a stock is a particularly great deal, don’t be afraid to put a large amount of money in it.  Sure, I sold bonds and put $120,000 in the stock market, but more than half of that money went into Coca Cola.

Of the above stocks, I was most convinced that Coca Cola was the best bet.  So I bought $65,000 of Coca Cola stock when I rebalanced my account.  You can read about my purchase here, while seeing what my rationale was behind it.

My second biggest purchase was Johnson & Johnson, at $57 per share…which cost me roughly $35,000.

Assuming that I still owned all of the above holdings today, the gain from rebalancing that $120,000 in June, 2010 would amount to $33,000—and that’s after the recent stock market drop.  However you slice it, $33,000 isn’t chump change.

During volatile markets, rebalancing between stocks and bonds adds some serious juice to your investment returns.

On August 20th, 2011 I rebalanced my account again, selling $50,000 of bonds and buying the U.S. stock index.  It’s silly to think short term, but that $50,000 is now worth $52,400.

Do I want the markets to keep rising?  Nope.

I want them to fall.

And one of my online buddies, Value Indexer, explains why—better than I could.

Keep an eye on your investment allocation, and adjust the holdings (to maintain your target allocation) during big market moves.

If the markets bounce up and down like a kid on a pogo stick for the next decade, you’ll make loads of money from the volatility while the world’s emotional investors lament about the fact that you can’t make money in stocks anymore.

When you hear that, just turn away and smile.