It was Yogi Berra who said, “It’s tough to make predictions, especially about the future.” His point is particularly relevant to investing. “Market timers tend to be lousy investors, and numerous studies show that they underperform those who buy and hold,” says Kevin Brosious, a Pennsylvania-based, fee-only certified financial planner and public accountant. “Not only is it … difficult, if not impossible to predict the markets, but frequent turnover leads to higher trading costs, and often higher taxes.”
Indeed, in one recent study from Duke University, it was estimated that heavy portfolio-tweakers underperform light portfolio-tweakers by 1.25 percentage points a year. And that’s before taxes. But that doesn’t mean you should leave your portfolio forever on autopilot. Here are four occasions when tweaking is well warranted:
Your portfolio is out of whack
A year ago, you crafted a moderately aggressive portfolio of 60 percent stocks and 40 percent bonds. Now’s the time to check your allocations. If stocks have been good to you and your ratio has risen to 65/35, it’s time to rebalance. That means selling off some stocks and buying bonds. You do this to keep your risk in check. The other reason is to force yourself to continually sell high and buy low. Over the long run, experts say, regular annual rebalancing could juice your returns by more than half a percentage point a year.
You are close to retirement
A major exception to the buy-and-hold guideline is when your life circumstances change dramatically. As you get closer to retirement, the common wisdom is to lower your risk by moving more savings into bonds, less into stocks. The reason is that once you retire, you will be pulling money from the portfolio, rather than putting money in. Should markets crash, an older person has fewer years to recoup the loss. A very general rule of thumb is to invest your age in bonds. “As rough rules go, this isn’t a bad one,” says Brosious.
Your funds have become obsolete
There’s been a revolution in both stock and bond funds over the past decade or so, and management fees have come down considerably. But not all funds have followed suit. According to Morningstar Principia, dozens of index funds simply track the performance of Standard & Poor’s 500 index (500 of America’s largest company stocks), but with vastly different fees. You can spend 0.05 percent a year in management fees for the Vanguard S&P 500 ETF (ticker VOO), for example, or you can spend 10 times as much (0.50 percent a year in fees) for the virtually identical Dreyfus S&P 500 Index fund (PEOPX). There’s rarely a reason not to switch when the price difference is this dramatic.
Your investments are too popular
Investors have a bad habit of making trendy investments. Trouble is, by the time they’re trendy, they’ve very often peaked (think tech stocks in 1999 or real estate in 2006). Buying a stock when it’s hot often means needing to dump it when it’s cold. “Not a profitable strategy,” says Neil Stoloff of SweetSpot Investments in Bloomfield, Michigan. Instead of buying high and selling low, you want to do the opposite, he asserts. Rebalancing (see No. 1) will help you to buy low and sell high as a matter of routine. But if you wish, you can go a step further; be a contrarian and purposely buy what others have been fervently selling, says Stoloff. “That’s what we do—at the beginning of each year, we buy whatever kinds of investments saw the greatest outflow of investor dollars in the previous year.” You needn’t work through the complex number-crunching that Stoloff does to take advantage of a contrarian strategy. Simply look to see what’s hot and what’s cold in the world of investments. What is your brother-in-law selling? What have all the chattering heads on TV and radio been advising you to dump? Move opposite the crowd. For example, if European stocks are unloved by the masses (as they have been of late), you might put five to 10 percent more in European stocks than you otherwise would.
Portfolio tweaks, by definition, are done in moderation. “Tweak, yes,” says Brosious. “Overhaul? … Only with very good cause and … the blessing of your tax advisor.”