How to buy low and sell high like a pro

by Rob on December 24, 2012

Since the prices of financial assets like stocks and bonds adjust rapidly to new information and changes to perceptions of risk, it is very difficult to judge when a particular kind of investment will skyrocket, move sideways, or tank.

Instead of buying low and selling high, one can easily do the reverse; that is “sell high and buy low.” Selling high and buying low is relatively easy because it is a simple matter to observe when an asset class (such as U.S. large company stocks or Emerging Market small company stocks – implemented by most individual investors with mutual funds or ETFs that are designed to provide exposure to those asset classes) has strongly appreciated or depreciated in relation to other asset classes in your portfolio. Once a change has occurred, you can easily sell funds providing exposure to the good performing asset class and buy funds implanting the poor performing one in order to bring them back into “balance”. This technique is called “rebalancing” and is one that you can periodically apply to the investments in your portfolio in order to keep it at your appropriate asset class mix.  In addition to this crucial benefit, rebalancing provides a structured approach to always “buying low” and “selling high.”

Although rebalancing is mechanically easy, it is not always emotionally easy because it requires you to sell a relatively “good performing” asset and purchasing a relatively “bad performing” asset (hence buying low and selling high).  Normal human instinct will lead you to continue buying assets that are doing well.  It is easy to imagine that the good (or bad) performance will continue. Unfortunately, this is not how things work.  So, imagine eating your vegetables by adopting a disciplined rebalancing process – which will definitely be good for your long-term financial health.

Finally, once way to mitigate the discomfort is to only do this once a year – say in December or January.  This is frequent enough to reap most of the benefit – but infrequent enough that you can summon the courage when necessary!

Comments on this entry are closed.

Previous post: