If you missed yesterday’s FZ Daily, go back and read it first. Good?
Okay, so if rebalancing doesn’t always work over the short-term, how long does it take to work?
It’s the economy, stupid!
(Don’t get offended. Google it.)
Each investment you own (if we’re talking a Financial Zen Portfolio) is tied to various economic cycles.
All economies boom (expansion) and bust (recession) That’s called the economic cycle.
Like day will follow night, expansions will follow recessions. It’s the circle of (economic) life.
And for the most part, different economies don’t boom and bust at the same time. Usually some are booming, while others are busting.
Why we diversify
Managing risk is not the only reason we diversify. We also do it to to take advantage of uncorrelated assets – aka economies.
We don’t want all our investments to zig and zag at the same time. We want some to zig at the same time others zag. We want some to bust while others boom.
For instance, when we come out of a recession, small cap stocks tend to lead the way.
Alternatively, when we’re late into an economic cycle, large cap stocks tend to do well.
Since 2008, Europe has trailed the U.S. So they’re where we were a few years ago.
Same with emerging markets. They’re even further back than Europe.
So each one is doing its thing and when we rebalance we invest more in the ones that are busting before they boom.
So how long is long enough?
A full economic cycle.
As we pour more money into emerging markets, we’ll have to wait until it’s expansion catches up with the U.S.
But by then we’ll probably be busting and be carving off gains from EM to reinvest in U.S. stocks.
How long enough is long enough? Until the ride comes to a complete stop (and then we’ll get back in line and ride it again).
