Buy Low and Sell High the Bragg Way

“Buying low and selling high” sure sounds appealing doesn’t it? As an investment strategy, what could be more intuitive, appealing or straightforward? Looking back at history, it is clear that a strategy of buying the lows and selling the highs would have resulted in returns that trounced the market averages. Unfortunately looking backward is of limited value when we must invest looking forward. While the concept is sound, the implementation is challenging. How do you know when to buy? How do you know when to sell? You don’t often hear us at Bragg Financial speak of “buying low and selling high.” It sounds too much like market timing, something in which we never engage. Or do we? In fact, we do! But our version of buying low and selling high is called rebalancing. Rebalancing is simply selling positions that have performed well and buying positions that have lagged.

As we see it, in order to buy low and sell high there needs to be a process in place. The process must be followed in good times and in bad times. The process must be consistent and repeatable. The process must be unemotional and disciplined.

Let’s assume an investor has determined that a portfolio allocation of 60% stocks and 40% bonds is appropriate given the investor’s need for return and tolerance for market volatility. Without a rebalancing process in place the 60/40 portfolio will drift over time, like a boat without an anchor.

Assuming there is no process in place, if stocks go up, a 60/40 portfolio could easily become a 70/30 portfolio. If stocks then reverse course and go back down, the market has rebalanced the portfolio to 60/40. Good? No. The investor missed a great opportunity to rebalance. The missed opportunity has two components:

• Rebalancing from 70/30 to 60/40 (trimming stocks and adding to bonds) prior to the market falling would have reduced the exposure to stocks, reducing the portfolio’s loss during the market decline.
• Rebalancing from 70/30 to 60/40 before the decline would have permitted the investor to rebalance again, after the decline, trimming bonds and buying stocks to return to 60/40 again.

For a more specific example of using rebalancing to convert market volatility into your ally, let’s begin with the same 60/40 portfolio and assume that thresholds are set to buy and sell if the portfolio drifts more than 5% from the target. If stocks increased to 65.01%, the investor would sell 5.01% of their stocks, lock in the gains, and purchase bonds. If stocks dropped to 54.99%, the investor would sell bonds and buy stocks bringing it back up to 60%.

What would a 60/40 portfolio look like today if an investor put $1,000,000 into a 60/40 portfolio in the year 2000?

60/40 Portfolio without rebalancing:

• Value of portfolio ending February 2019: $2,700,873.
• Allocation Drift:
  • In 2009 the portfolio would have been 40% stocks and 60% bonds.
  • In early 2018 the portfolio would have returned to the original 60% stocks and 40% bonds.

60/40 Portfolio with rebalancing:

• Value of portfolio ending February 2019: $2,945,348.
• During the time period, the portfolio would have been rebalanced fifteen times.

What would a 60/40 portfolio look like today if an investor put $1,000,000 into a 60/40 portfolio in the year 2000 near the peak of the tech bubble, and planned to withdraw $36,000 per year ($3,000 per month) to supplement living expenses? The draw will increase annually at the rate of inflation (CPI).

60/40 Portfolio without rebalancing:

• Value of portfolio ending February 2019: $1,024,499.
• 17 years and 3 months: Period between portfolio peaks. The portfolio would have peaked at $1,021,704 in August of 2000, declined to a trough value of $660,856 in February 2009, and would have returned to its August 2000 high in July of 2017.

60/40 Portfolio with rebalancing:

• Value of portfolio ending February 2019: $1,147,690.
• 13 years and 6 months: Period between portfolio peaks. The portfolio would have peaked at $1,021,704 in August of 2000, declined to a trough value of $612,232 in February 2009, and would have returned to its August 2000 high in February of 2014.

The greatest obstacle to disciplined rebalancing is emotion. Assume the $1,000,000 investment was the investor’s retirement savings and the investor’s goal was to retire in 2010. From November of 2007 through March of 2009 stocks lost approximately 50% of their value. If it took that investor 30 years to accumulate $1,000,000, then $300,000 (assumes 60/40 allocation) was wiped out in a matter of 16 months. In addition, assume the investor needed to begin withdrawing money in 2010 to fund retirement spending. During that timeframe the investor would have been bombarded with ominous headlines, recommendations from friends, and Wall Street pitches for products offering an “alternative to stocks.” Having the discipline to continue to sell bonds and buy stocks is difficult, to say the least. That’s when an unemotional process is needed the most.

Owning a 60/40 portfolio and implementing disciplined rebalancing is unlikely to outperform a portfolio that is 100% stocks over the long term. Stocks will likely continue to beat bonds over time, if given enough time. But many investors require liquidity; they rely on the portfolio for withdrawals. A pure equity portfolio encumbered with a significant draw may prove unsustainable during a major market decline. This is when a balanced portfolio with disciplined rebalancing can prove to be the prudent course.Having a process to trim stocks as markets climb creates an ever-growing pool of stable bonds (dry powder). Over the last ten years, as the market has climbed almost 300% from its lows of March of 2009, it has resulted in many of our clients having more money in stocks than ever before. But at the same time, rebalancing (trimming stocks and adding to bonds) as the market has climbed has resulted in their having more money in bonds than ever before as well. The larger bond portfolio provides the liquidity as well as the dry powder to use for rebalancing when the next downturn comes our way. And it will.

Having a process to buy when stocks are down allows us to ignore emotion and rebalance when times get tough. As Warren Buffet put it “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”

Data: Obtained through portfoliovisualizer.com.

Stock market proxy used in models was Vanguard Total Stock Market Index (VTSMX). Bond market proxy used in models was Vanguard Total Bond Market Index (VBMFX). Returns ignore taxes and trading expenses and are for illustration purposes only. Past performance does not guarantee future results.

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.