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“Surveys indicate that the people who most need an advisor or a systematic plan don’t use either. “Static rebalancing forces investors to sell high and buy low systematically.” - Harry S. Dent, Jr.

One of the best ways to take the emotions out of managing your assets is to:

• Choose the asset classes you want to invest in, keeping in mind which classes are favored by long-term fundamental trends.
• Decide what percentage of the total value of the portfolio you want to allocate to each class depending on your risk tolerance and the optimal combinations for diversification of risk.
• At regular intervals, for example every year, sell or buy in each asset class to return your portfolio back to the original targets, forcing a systematic tendency to buy low and sell high.

Here’s an example. Suppose you want to create a growth portfolio suitable for the current economic boom with a starting value of $100,000. You or your advisor decide on an initial allocation of $100,000 diversified within the best two sectors, large cap stocks and international. Your original portfolio look like this:

• 40%, or $40,000 in high technology
• 25%, or $25,000 in financial services
• 15%, or $15,000 in health care
• 20%, or $20,000 in Asia, excluding Japan

After a year, it is time to rebalance the portfolio. Your high technology stocks grew 37% and are now worth $54,800. The financial services stocks grew 23% and are now worth $30,750. The health care stocks grew 19% and are now worth $17,850. And the International sector (Asian equities) grew at 33% and is now worth $26,600. At the end of the first year, the total value of your portfolio stands at $130,000, a 30% gain.

To rebalance this portfolio to its original target values of 40% technology, 25% financial services, 15% health care and 20% Asia, you would

• Shift $2,800 out of technology, lowering it to $52,000.
• Shift $1,750 into financial services, raising it to $32,500.
• Shift $1,650 into health care, raising it to $19,500.
• Shift $600 out of Asia, lowering it to $26,000.

One reason why systematic rebalancing is a reliable portfolio management strategy is that it is based on probability. An asset class that performed very well in one year is less likely to perform as well the following year. By redistributing earnings from the highest-return classes to the ones with lower returns, you force yourself to sell high and buy low systematically, without fear or greed making the decisions for you. Over time, systematic rebalancing should marginally improve your returns and lower your risk.

If you want even higher returns, we recommend another portfolio management technique called dynamic portfolio rebalancing.