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Lessons from 2009: Rebalancing and Investment Horizons

One of the things 2009 reinforced was that discipline is necessary for maintaining a successful investment plan. Bear markets can make it tough to remain disciplined, but if you feel the need to do something, consider realigning your portfolio with your investment plan.

Bear Markets Turn 30-Year Horizons Into 30-Day Horizons
After the S&P 500 Index fell 37 percent in 2008, investor discipline was tested again in early 2009. By March 9, the S&P 500 had fallen about another 25 percent.

Warren Buffett once said, "The most important quality for an investor is temperament, not intellect." The evidence from research on investor returns versus investment returns demonstrates that investors' worst enemy can be their emotions -- greed and envy during bull markets and fear and panic during bear markets.

One key to being a disciplined investor is to understand that bear markets are inevitable and unpredictable as to their timing, length and depth. Another key is to know that the world is never really as dark as it appears to be during a bear market (nor as bright as it seems during bull markets). Knowledgeable investors know bear markets are accompanied by countercyclical policy actions. And they also know that the stock market is a leading economic indicator, anticipating that such actions will be taken. That's the reason for the cliché that investors make the greatest returns during tough economic times, it's just that they don't know it at the time.

When the Going Gets Tough, the Tough Rebalance
Most people find it easy to stick to a plan when things are going well. However, it becomes more difficult when bear markets show up. Stomachs start to churn, sleep gets lost and all-too-often the stress leads to the abandonment of plans and panicked selling.

The winning strategy is to have the discipline to rebalance, in good and bad times. Those who had the courage to ignore their stomachs and rebalance have now recovered a much greater share of the losses inflicted by the bear market of 2008 and early 2009 and are much closer to achieving their financial goals.

It's also important to remember that those who regularly rebalanced after the years of strong returns we experienced during the late 1990s (selling equities to buy more fixed income), suffered smaller losses than those who simply let the portfolio ride right up into the bear market that began in March 2000. In addition, the investors who lowered their equity allocations due to those great returns (since they now had a lesser need to take risk) suffered even less, both mentally and monetarily, when the 2000-02 bear market arrived.

The same thing is true for those investors who where still there to earn the strong returns the market provided from 2003 through 2006 (especially in 2003). By rebalancing or possibly lowering the equity allocation, they experienced smaller losses in 2008 than they would have otherwise.

Follow the series: Lessons from 2009

  • Part one: Planning Tips and Investment Myths
  • Part two: Rebalancing and Investment Horizons
  • Part three: Unexpected Bursts and Staying Invested
  • Part four: Refreshers