As the stock market has turned downward again, many investors are scurrying to protect their portfolios. The protection that investors are buying, though, comes at the highest price ever -- and as a result, many are taking their portfolios in exactly the wrong direction.
Getting the timing wrong again
Back in April, everything looked great for stocks. The market had rallied strongly for more than a year, and there were some signs that the economy was starting to get moving again. After months of skepticism, retail investors finally returned to the market, putting billions of dollars back into U.S. stock mutual funds.
Yet looking back, that was the time when investors should have been rebalancing out of stocks. With the S&P having risen as much as 80% from its March 2009 lows, investors who had a 50/50 asset allocation to stocks and bonds at the bottom of the market could have seen their stock allocations rise to 60% or more. In other words, without doing anything more than just sitting on their investments, they were taking much greater risk than they may have believed.
Conversely, now the market has corrected by more than 10% from those April highs. But are investors clamoring to buy cheap stocks? Nope. Investors are again flocking to the top performance of bonds. However, with long Treasuries having risen more than 20% since the beginning of the year, versus a 5% drop in stocks, those who rebalanced at the end of 2009 are starting to see a disproportionate emphasis on bonds -- even if they haven't added more money to their bond positions.
Buy what's cheap
If you treat the stock market like you do the shopping mall, you'll see your performance improve dramatically. Instead of chasing after the highest-priced hot-ticket items, waiting for clearance sales on investments can save you a bundle. Right now, that means reducing your bond exposure in favor of getting your stock allocations back to where they belong in order to meet your long-term investing goals.
Rebalancing can also work across different kinds of stocks. For example, consider how various types of stocks have performed so far this year, with the S&P down around 5%:
- Thanks to the European crisis, big-economy foreign stocks have fallen more sharply, down 7%. But emerging markets have held their own and are roughly unchanged for the year.
- Among sectors of the market, defensive stocks like telecom and consumer-oriented stocks have held their own quite well. Tech and energy stocks, on the other hand, have fallen off a cliff and are down double-digit percentages for the year.
Rebalancing also involves moving your stock money around to take advantage of temporary bargains. Sure, many have looked to the power of dividends as a justification for pushing up the prices of Windstream
Instead, though, it's a great time to look at the wreckage of bad-performing areas. ExxonMobil
Rebalancing isn't something you need to do every day. But when markets move violently, you should keep an eye on your investment exposure to make sure it doesn't get too far out of line with where you want to be. Once it does, the key is to make the tough decision to sell some of your winners to grab bargains while they last.
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Fool contributor Dan Caplinger has just enough balance to ride a bike. He owns shares of Chesapeake Energy. Chesapeake Energy, Google, and Microsoft are Motley Fool Inside Value picks. Google is a Motley Fool Rule Breakers recommendation. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Chesapeake Energy, ExxonMobil, and Google. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy never puts off until tomorrow what it can do today.