Rebalance

Last week I wrote about Carl Richards and his view on the “The Behavioural Gap” where we as investors buy out of greed and sell out of fear, causing us to lose money.
Allan Gray as an asset management company often comments on how investor behaviour drives bad returns. The average investor has worse returns than the unit trust they have invested in. This seems counter-intuitive; surely if the investor is investing in a unit trust with good returns, then the investor should be seeing the same return. However this doesn’t happen because investors usually sell when the unit trust is doing badly and buy a unit trust when it is doing well. Here, again, we see greed and fear driving investor behaviour. The unit trust itself does do well but the investor performs badly because his or her behaviour is motivated by greed and fear.

If one is invested in two or more unit trusts and one of the unit trusts outperforms the other unit trust consistently, it could outperform to such an extent that the weighting of the unit trusts change. For example, if you are invested 50% in an equity (shares) unit trust and 50% in a money market unit trust and the equity unit trust outperforms the money market unit trust, there is a shift in the value of your portfolio. The shares in the equity fund would have grown in value and because it has grown, the weighting or percentages would have changed. You would no longer be invested 50% equity and 50% in money market, but due to the increase in price, you would be invested 60% in equity and 40% in money market. This scenario isn’t purely hypothetical as The Johannesburg Stock Exchange has done well in the past 5 years, hence money invested in equity shares would have done well.
Would you rebalance? Would you rebalance your unit trust to 50% equity and 50% money market? If we look at usual investor behaviour, it would have to be a resounding “no”. Investors do not rebalance. Investors leave their unit trusts as is, because they are making money and their investment is growing. But the investor‘s behaviour is now motivated by greed. Some investors might even go so far as to buy more equity shares, driven not only by greed but behaving so out of fear. Fear of not making enough money, fear of losing out on a potential windfall.
However one would have to rebalance one’s original asset allocation if it was determined by risk profile, risk tolerance and term of the investment.  If the equity markets have done well, then they will retract to some extent. In that case the investor would have been happy that they had rebalanced as they had banked the gain. By rebalancing you are investing for the long term, not just following the herd and buying high and selling low. You are not letting greed and fear to motivate your investments but you are rather investing for the long term, allowing your investments to grow.
Next time we will be looking at how to focus our investment decisions by not getting caught up in worries about rising fuel prices or fluctuations in currency values.