Learn about a powerful way to take advantage of market fluctuations.
Ric Edelman is a co-founder of Edelman Financial Engines. The following is taken from his weekly radio call-in show.
Question: My wife and I follow your advice to own a well-diversified portfolio that fits our particular situation. You always say that investors should buy low and sell high and view stock market declines as good buying opportunities. But what money do we use to buy low? We don’t have extra money lying around to invest. Do we sell some of our investments in order to buy others, or what?
Ric: That’s a great question. You quoted me accurately: Buying low and selling high is a truism, and it’s good to take advantage of dips in the market to buy. But what if you don’t have any money to do that?
Well, here’s another truism that’s even more important: The best time to invest is when you have the money. If you don’t have any money, it’s a bad time to invest.
You seem to be saying that you don’t have any money because all of your money is already invested. You don’t have any cash in your pocket, a coin jar filled with quarters or $200,000 in excess cash reserves sitting in a checking account. You wish you did because prices are low, but unfortunately you don’t.
So here’s what you do: It’s called rebalancing. Rebalancing takes advantage of the buy-low/sell-high principle. During the dramatic drop in stock prices last August, many people — including the media — overlooked the fact that while the stock market was falling, the bond market was rising. Rebalancing takes advantage of situations like that. When bonds are up, you sell some and buy some stocks that are down. In that way you sell high (the bonds) to buy low (the stocks). And you would do the same regarding other asset classes. When you rebalance, you sell some of the overperformers and buy some of the underperformers.
You can engage in rebalancing on your own or hire a financial advisor who engages in strategic rebalancing to help you. Rebalancing can be done on a calendar basis (at certain times of the year — say, quarterly) or it can be done on a percentage basis.
The latter is how we do it: When certain assets in the portfolio drift beyond the allocated percentage originally set for them, we rebalance to bring them back to their desired allocation. We review our clients’ portfolios and rebalance as needed. Whether you choose to rebalance by calendar (which is less efficient) or by percentage as we do, make sure it gets done.