We’ve said on several occasions that extreme highs will almost always be followed by a subsequent return to the regression line. Day traders and swing traders are well aware of this fact, and they tend to “take some off the table” when a target threshold is reached. This is such a common theme that it may seem imprudent to invest in a diversified portfolio and leave it alone the vast majority of the time. Shouldn’t we sell when we’ve done great, and an investment has nowhere to go but down?
The answer to that question is rebalancing. When you follow the advice laid out in the final chapter of this book, you will devise an allocation strategy and specify what percentage of your portfolio will be dedicated to what particular assets. If you had decided on a split of 50% bonds and 50% stocks during the past year, you would not have the same ratio now. It would be something like 60% stocks and 40% bonds because equities have done very well. Rebalancing (which I suggest you do yearly) means that you would sell 10% of your stocks and buy bonds with the proceeds. This would restore your balance of 50% / 50%.
Rebalancing is one of the hardest things to do in investing. Your greedy midbrain will throw a temper tantrum and rail against your logical brain trying to “sell winners to buy losers.” Why would you sell those awesome S&P 500 fund shares and buy stupid bonds? Because those awesome S&P 500 fund shares are more likely than not to revert to the mean before resuming their upward march. Your poorest performers will receive the biggest share of money from rebalancing, and they have the most “room to run.”