Many investors make the mistake of buying a stock or mutual fund simply because its share price has been going up for a while. As the price rises, people get excited and want to jump on the bandwagon “before it’s too late”. The problem with this method is that it goes against one of the core principles of investing: buy low, sell high. Once the stock price starts going down, many of those same investors will panic and some will sell their shares.
The chart above contains a list of asset classes and their performance over the years. It includes indexes of large companies, small companies, international stocks, emerging market stocks, etc. Each of these asset classes can be invested in directly through index funds or actively managed mutual funds. Pay attention to the color of the individual cells, as each color represents a specific asset class. As you can see, the performance of any individual asset class can change drastically from one year to the next. For example, in 2006 the REIT fund was the top performing asset class, returning 35% (REIT stands for Real Estate Investment Trust and it tracks real estate). However, the very next year, it lost almost 16%. In 2007, the top performing asset class was Emerging Market Stocks (with a gain of almost 40%). Yet again, the very next year, Emerging Market Stocks lost 53%. Ouch! The year after that, Emerging Market Stocks gained 79%.
Since it’s impossible to predict how different asset classes will perform in any given year, it’s important to diversify your investments between different types of assets. Then, once every six to twelve months, you would sell some shares from the top performing fund (sell high) and add money to the fund that had the worst performance during that same time frame (buy low). For example, at the end of 2006, you would have sold some shares from your REIT fund and would have bought shares of High Grade Bonds fund. In 2007, you would have sold some of your Emerging Market shares and bought some additional REIT shares, and so on.
One way of doing this is by re-balancing your account, which Inveduco recommends to do every six months, or at least once a year. The easiest way of doing this is to setup a reminder in your calendar to bring your portfolio back to its original allocation once every 6 to 12 months (some robot-advisors will automatically rebalance your account anytime one of your funds starts taking up too much weight in your overall portfolio.) Our advice is to decide how often you want to rebalance your account and then setup a reminder.