The recent plunge of stock markets around the globe – of some 10 percent in August only – makes the need of rebalancing investment portfolios pressing.
Traditional portfolio theory stresses the need to rebalance once a year after thinking carefully of exposure and basic investment strategy.
In the process of rebalancing, one looks at how targets have changed over the year and then revalues the risks of over or under exposure to different assets classes. You then end up with a more balanced portfolio ready to face the new year ahead.
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The problem is that since 2008, individual investors have been rightly cautious of dipping their feet into the stock markets and are probably now underweight in stocks and overweight in T bills and cash.
With the 10 year T bill touching a historical low of below 2 percent, it might be the time to sell some of those and replace them with other assets. Can the yield go lower? Probably not.
Is it smart to invest a substantial part of one's portfolio in a money market account which pays nearly zero interest rate ? Probably not.
Investors should look closely at the large multinationals who offer higher dividends than the U.S. T bills which have free cash flow and probably have more cash than the government.
One should look for multinationals that have pricing power even in periods of recession as well as significant sales to Asia and other high growth economies – such as food or consumer goods companies.
The recession-proof, dividend paying companies will help protect one’s portfolio even when entering a period of inflation at a later stage of the economic cycle.
With many multinationals at historical low P/E and P/B, one should look for companies with a large proportion of their sales in high growth emerging economies.
Yum Brands, which has over half of its sales in such regions, and Procter & Gamble, whose revenue from international markets is expanding rapidly, may prove attractive to the individual investor.
Yum pays a dividend of 2 percent whereas P&G pays a large dividend of 3.4 percent, increasing it every year, unlike a U.S. 10-year T bill, which is fixed.
Rebalancing should be coupled closely with an analysis of funds held in the portfolio – looking carefully at their holdings. In many cases, investors will find out that various funds are holding the same companies. During these volatile periods, one should also look at individual positions in companies and ask oneself why you invested in them to begin with.
If the fundamentals are still there, there is no need to panic and sell but rather rebalance one’s portfolio and maybe add to these stocks.
According to Benjamin Graham, stock owners shouldn’t be too concerned with erratic fluctuations in stock prices.
If one cannot sleep well at night because of high volatility than maybe one shouldn’t invest in the stock market.
Personally, after rebalancing my portfolio during periods of ultra high volatility, I switch off CNBC and go with my kids to the beach.
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