When people think about investment, most of us think about stocks. Market experts always tell the story of if you have invested in the stock market for 50 years between 1950 to 2000, the annulized market return is about 9 percent. That suggests if you buy and hold stocks for 25 years, your $100,000 portfolio would increase to $800,000, theoretically. That is very good if your portfolio works as "planned". But most people I know have lost money in their "short" investment career. For the past 10 years, buy and hold strategy has been greatly challenged. If you have your money invested in SP500 index fund, you are down 33% for the 10 year period, which means your initial portfolio of $100,000 10 years ago, now is $67,000. That is good for your tax return, but not good for your retirement. For individuals who started their investment 10 years ago and had initial goals of 25 year investment time frame before retirement, a significant part of this period has passed and they had to painfully watch their retirement portfolio going southward. They may have to postphone their retirement plans unless market experience some dramatic upward movement for the next 15 years. Can we bet on it? Probably not. 

There are many investment asset classes, such as US stocks, international stocks, fixed income(bonds), precious metals, energy, real estate etc. If we have a diversified portfolio, how did we do for the past 10 years? According to Morningstar.com, annualized return for the past 10 years for all the funds is 1.62 percent. $100,000 portfolio now worths $117,000. From this data we can see the diversified portfolio performed better than just buy and hold general stocks. However, the return is still not enough to offset the inflation rate. With the market volatility like we have now, pure buy and hold of a diversified portfolio is not enough. How can we make it better?

Analysis of all asset classes shows that each asset class has its own bull and bear markets. If we just hold each asset class through bulls and bears, the bear market losses signifcantly offset the gains we have in the bull markets. Everyone is thinking if we only invest in the bull markets, how wonderful it is going to be. Reality is that predicting each bull and bear market is a difficult tast if not impossible. Now, rebalancing asset allocation comes into play. How does it work? Let's say that you hold a portfolio of diversified assets, for example, 20% in technology stocks, 20% in energy stocks, 20% in precious metals, 20% in fixed income, 20% in real estate. If technology stocks experience a bull run, and other asets lag in performance, the percentage of technology stock value in your portfolio increases to 26%. Then you need to consider take some profit in the technology stocks and put the profit in the underperformed assets. By this way we re-adjust the portfolio into the original ratio. Now we have more shares in the underperformed assets. When the underferformed assets start to increase in value, then you have more shares work for you. Of course, then you need to rebalance your portfolio again. By this method, you are doing something called "buy low and sell high". Isn't that we suppose to do in investment?

I really welcome more discussing on this issue. If interested, you can email me at  [email protected].



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Asset allocation and rebalancing

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