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ONE day the market is up, and the next day, it’s down.

If you are an investor keeping up with the current trends, you’ll probably have noticed that the past several months has been a bear market for investors around the world.

Despite all signs pointing to economic recovery after the easing of the pandemic, investors hoping to have a respite are finding it worrying as concerns over high inflation, the Ukraine war and the lockdown in China are hurting investor confidence.

So, what should one do in such volatile markets? While less experienced investors might start panicking and pull their funds out, this is not the right strategy to pursue during volatile markets.

The investment mantra “buy low and sell high” should always be at the forefront of every investor. But it is easier said than done, as it requires strategising.

As such, if you were to pull out your investments now, not only do you rob yourself of the opportunity to sell high later on and optimise your profits, you would also cement any unrealised losses into realised losses.

A ‘buying low’ alternative

A bear market can be the perfect opportunity to buy more stocks at cheaper prices. Investors who are able to stomach the strategy can lower their dollar-cost average, thus bolstering their investments against further volatility.

If the prospect of investing even more money in a bear market makes you nervous, then perhaps applying the rebalancing strategy would be more suited for you.

So, what is rebalancing?

The term “rebalancing” refers to the act of maintaining your asset-class allocation ratios to diversify your portfolio and protect your investments against uncertainties.

By diversifying your asset-class allocation, you reduce the likelihood of all your investments being affected should the market suddenly turnaround.

But your role doesn’t end once you have finished structuring your asset allocation. As time goes by, different assets will perform at different rates, causing your portfolio to fall out of its original asset-allocation ratio.

Regular reviews and rebalancing of your investment portfolio is thus needed to ensure that your strategic allocation remains relevant and in place.

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Portfolio rebalancing

At Whitman, we recommend our clients rebalance their portfolios once every six months or when the portfolio goes more than 10% out of its original ratio.

As seen in Table 1 after six months of investing, both cash and bond asset classes fell to 17% and 26% respectively, while equity grew from the initial 50% to 57%.

According to the rebalancing strategy, you should readjust your investment portfolio to safeguard from being overly exposed to undesirable risks and maintain your risk tolerance.

To do this, you’ll need to sell some of your outperforming asset class and use the proceeds to buy more under-performing asset classes.

To do this, you would need to sell RM167,000 worth of your equity and buy RM69,200 worth of cash and RM97,800 worth of bond to return to the original asset allocation weightages.

While this may seem logical on paper, in practice, it is not the easiest thing. You’re selling off the asset that has given you the best return to buy more of the assets that have under-performed.

It almost feels counter-intuitive to what you’re trying to do – grow your wealth! However, if you want to stick to the strategic asset allocation and maintain your risk tolerance, that’s exactly what you must do.

When you rebalance your investment portfolio, you’ll end up practising one of the most important investing strategies mentioned earlier: that is to buy low and sell high.

Profiting from an underperforming equity market

If you have invested in equities, you may have realised that some of your equities have been underperforming as of late. So, how does one rebalance to mitigate against losses? Lets take a look at the example below:

As you can see from Table 3, bonds start out being 30% of the investment portfolio, while equities make up the remaining 70%. Due to recent market volatility, equity has dropped by 20%, throwing the balance of the portfolio out.

Due to the severe drop in equities and the loss that the portfolio is garnering, we would recommend a rebalancing despite it being less than six months.

From the calculations in Table 4, you would need to sell RM44,100 of the bond asset class and invest that money into the equity asset class in order to maintain the original asset allocation.

When you adhere to the rebalancing strategy, you do not have to worry about what you should or shouldn’t do in challenging market condition. The strategy automatically calls for you to buy low and sell high.

Rebalancing does not require you to invest additional money during a bear market. Instead, the strategy would have automatically factored that in when it utilises the gains to buy lower preforming assets.

Pre-requisites for the rebalancing strategy

There are two pre-requisites or assumptions that must be fulfilled for rebalancing to work.

Firstly, your investments need to be best-of-breed quality in it’s own asset class. For example, if you have invested in equities, you should first do your research to ensure that this is one of the reliable equity funds managed by a competent fund manager.

If you have done this, and when a price drop occurs, it would be due to the overall market sentiment and not because of the poor performance or management of your specific investment asset.

Secondly, you must ensure that you have holding power.

The money that you put aside for your investments should be an amount that you will not need in the near future. This means that you must have adequate emergency funds for yourself (recommended 12 times your monthly expenses) that you will not need to withdraw from your investments in times of need.

If you don’t have the holding power and you need to use the money urgently, you may be forced to sell your investment at a bigger loss.

Conclusion

Buying low and selling high is a strategy that is easier said than done. When the market takes a turn to be unpredictable and you are unsure of what you are doing, this can cause you to freeze up in fear, thus leading to inaction and resulting in a poor yield or loss of your investments.

In order to prevent such situations, the rebalancing strategy gives you a clear, objective and methodical approach to ensure that your investments are constantly optimised and bolstered from market volatility.

Therefore, in a uncertain market such as this, my advice to you is same as that of to my clients: re-examine your portfolios, rebalance as necessary and monitor closely for corrective actions.

Yap Ming Hui is a licensed financial planner. The views expressed here are the author’s. Any reliance you place on the information shared is therefore strictly at your own risk.