By now you’ve likely read a few dozen “second half” investing strategy ideas being offered online. Here’s the only one that matters: rebalancing your portfolio.
I understand why financial journalists peg these stories to the calendar. They’ve got space to fill and often there is nothing in the stock market to talk about.
Yes, there are headlines galore. Political news, interest rate news, earnings and so on.
But the fact is, there’s nothing about the midway point of a year that has any meaning at all.
And yet here they come, financial advisers happy to talk on air about the second half, big investment houses doing the same, and of course the typical meaningless stock timing calls one always sees.
Why rebalancing instead? Because time-pegged financial news leads to two key investment errors, one cognitive and one emotional.
The cognitive error here is confirmation bias. There’s a lot of math behind this at the academic level, but the basic idea is that we tend to readily believe stories that fit our own preconceptions.
For instance, let’s say you’re invested in a given stock or sector of the economy that has outperformed the market handily. You could be disposed to believe a downturn in that stock is imminent — or that more gains are ahead.
Chances are, whatever that stock or sector is, there are headlines out there saying in explicit terms “Get out of stock X or sector Y in the second half.” Or, if you like, “Time to buy more of stock X or sector Y.”
If you want to hear either of these arguments, the internet will give you exactly that. Go ahead and type any stock symbol you like and “second half” into a search engine and see what happens.
You read what you already believe and, bias confirmed, take action. Mistake.
The other bias, the emotional one, is overconfidence. Say you have some knowledge about a given industry or a part of the economy.
Maybe you work in tech or banking. Maybe you’ve owned a given large-cap stock for a decade already and you follow its CEO closely.
It can be very hard to admit to being wrong once you’re invested in your own story of personal stock selecting skill. Maybe too hard. So the tendency is to seek out evidence that support your own theories about the second half of the year.
Here’s the thing: You’ll be right a lot of the time and wrong some of the time. But that basic pattern is true of investments in general. Your “knowledge” is meaningless at best and introduces unnecessary risk at worst.
Stocks at the index level go up most of the time. Occasionally they decline. It’s not likely that you’ll be able to game your way into owning stocks only when they rise.
In fact, full-time investment professionals spend thousands of hours trying to do this. Most fail to “guess right” the direction of the market any better than the indexes themselves.
And that’s the key. Because so many highly trained pros are move huge amounts of capital around, they are in fact “the market.” Not the latest earnings forecast. Not the consensus of Wall Street analysts.
And not the completely meaningless tick of a calendar from the first six months of the year to the next six months.
Burt Malkiel, Princeton professor and author of “A Random Walk Down Wall Street”, eloquently explains rebalancing as the only near-perfect investment strategy. Malkiel is on the investment committee of my firm.
Just rebalancing a couple of times a year means you automatically sell some of your short-term winners and, in the same move, buy some of your short-term losers at a lower price.
The result, if followed with discipline, is better returns with lower risk, a kind of investment magic nearly impossible to find otherwise, as Malkiel explains.
“We all wish we had a little genie who could reliably tell us to ‘buy low and sell high.’ Systematic rebalancing is the closest analogue we have,” Malkiel writes. Better returns follow from discipline, and discipline follows from understanding what really drives long-term portfolio returns.
Harnessing that knowledge is fairly easy, but it means letting go of dangerous biases first — and that can be hard for humans to do.
By: Mitch Tuchman, July 18, 2018