If you've paid any attention to financial markets lately, days like today and weeks like this week provide examples of the value of establishing and following an Investment Policy (IP). Among other things, an IP establishes your target asset allocation and rebalancing policy. So when stocks drop much, all you do is check your current asset allocation to determine if your rebalancing policy requires shifting some money from fixed income (CDs, bonds, cash) to stocks.
If you're really lazy, which isn't necessarily bad when it comes to investing, your investment policy could include something as simple as contributing a certain percent of income to your 401k or 403b plan at work, and holding everything in a target date retirement fund. In this case, there is no need to check your portfolio or pay attention to financial news, since no rebalancing ever is required--the fund does it for you.
Or maybe you have one or two stock funds and a bond fund, and your rebalancing policy is to rebalance once per year on your birthday, or on some other set date. Then you can ignore your portfolio and financial markets except for that one day each year.
Another common approach is to use more than one fund, and rebalance when your actual asset allocation (AA) deviates from target by more than a predetermined amount. For example, you could have a target allocation of 70% stocks and 30% fixed income, with a rebalancing policy of rebalancing back to target if your asset allocation deviates by 5% or more from target. So you would sell stocks and buy fixed income if your AA hit 75/25, or vice versa if it hit 65/35.
If you hear or see that stocks have dropped a lot, it might be worth checking your AA against target. Using the example in the previous paragraph, if you check today and see that your AA is 67/33, you've done your financial work for the day, and can get on with other things, since your rebalancing band has not been breached.
Having an Investment Policy and sticking to it helps remove the emotion from investing, which almost always is a good thing.
If you're really lazy, which isn't necessarily bad when it comes to investing, your investment policy could include something as simple as contributing a certain percent of income to your 401k or 403b plan at work, and holding everything in a target date retirement fund. In this case, there is no need to check your portfolio or pay attention to financial news, since no rebalancing ever is required--the fund does it for you.
Or maybe you have one or two stock funds and a bond fund, and your rebalancing policy is to rebalance once per year on your birthday, or on some other set date. Then you can ignore your portfolio and financial markets except for that one day each year.
Another common approach is to use more than one fund, and rebalance when your actual asset allocation (AA) deviates from target by more than a predetermined amount. For example, you could have a target allocation of 70% stocks and 30% fixed income, with a rebalancing policy of rebalancing back to target if your asset allocation deviates by 5% or more from target. So you would sell stocks and buy fixed income if your AA hit 75/25, or vice versa if it hit 65/35.
If you hear or see that stocks have dropped a lot, it might be worth checking your AA against target. Using the example in the previous paragraph, if you check today and see that your AA is 67/33, you've done your financial work for the day, and can get on with other things, since your rebalancing band has not been breached.
Having an Investment Policy and sticking to it helps remove the emotion from investing, which almost always is a good thing.
Great reminder to start checking on my IP! I need to get back into rebalancing my assets...
ReplyDeleteExcellent post as always, Kevin.
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