When markets go through tough periods, I have a lot of conversations with clients to reassure them that their plan is still strong. It usually helps for them to see that drops in stock values, though sometimes significant, are temporary and usually followed by a period of very strong returns. It becomes apparent to them that rather than sell, they should hold tight. Some even say, “wow, then this would be a good time to buy”. What began as concern over hearing that the value of their portfolio has fallen, will often turn to regret that they are not in a position to buy. In fact, they are in a position to add to stock markets. Here’s how.
When I build a client’s portfolio, I have a target percentage that I calculate for each part of the market. We call it asset allocation. It might be something like 15% in Canadian Stocks, 20% in US etc. As time goes by, some areas of the market do better than others some percentages increase and some decrease from their target weights. When stocks fall substantially, the percentage that clients have in them fall as well while the amount they have outside of the stock market, usually in bonds, rises. That is the perfect time to rebalance. This means reducing the weight in areas that are now higher in weight (bonds) than the target you set by selling a portion and using the money to buy in the areas that have fallen (stocks) below the targets. It’s putting into practice the classic rule of sell high, buy low. It is a good idea to do this when stocks are rising as well. It forces you take some profits along the way so that when markets fall, you’ve locked in some of your gains. Doing this regularly not only helps manage risk, it adds meaningfully to your compound returns.