The Danger of Portfolio BalancingMany brokerage houses offer portfolio balancing between different asset classes to minimize risk. The idea is that you can reduce your risk by having a mix of fixed income assets such as treasury notes or municipal bonds and a variety of small cap, large cap and international stocks. If your stocks are booming, you should sell some of your gainers and put the gains into your fixed asset classes.
However, during down markets, your cash reserves are higher relative to stocks that have lost value. In this case, portfolio balancing consists of buying stocks at the depressed values in the hope that they will eventually grow. But what happens when the stocks continue to go down in value? Should you continue putting good money into stocks that are likely to lose value? I don't think so. During these times it is probably more prudent to keep your cash and fixed income assets and wait for the market to stabilize.
Brokers say that you never know when the stocks will go up. They insist that gains are made during sudden market moves. You have to stay invested in order not to miss the upward market movements. I think that the times are changing and the old rules don't work. The market has dropped so much and so fast that if you had put all your assets as fixed income at the beginning of 2001, you would now have more money than if you had invested in the S&P 500 index or a fund based on the Dow-Jones index -- even accounting for inflation and all the dividends! Automatic portfolio balancing is dangerous because it can reduce your funds substantially during a long period of recession. With current market conditions, it may be wise to wait for a period of economic stability that lasts at least three months before you put some of your hard-earned cash into stocks.
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