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In an ideal world, every stock market trend–up, down, sideways–would begin on January 1 and end on December 31. That would make an annual rebalancing of any portfolio as easy as falling off a madly spinning log in a Canadian logging festival.

Most market trends don’t cooperate. They start early or end late and just make picking a date for selling long term losers, adding to promising positions that are temporarily down, or taking profits in winners from whatever the trend was, difficult.

And sometimes the trend’s timing doesn’t just make a rebalancing difficult–sometimes it makes it downright daunting, head-scratchingly hard.

You–or I in this instance–wind up wondering if rebalancing on the normal annual schedule is the best move or would it be smarter to wait until the trend seems to be peaking or has turned?

And that was/is the case with 2018 and 2019.

The Standard and Poor’s 500 lost 4.23% (including dividends) in 2018 thanks to an end of the year near bear market.

The index, however, gained 29% last year.

Which has made the two-year period a case study that can teach us something about how/when to rebalance a portfolio. A single two-year period isn’t exactly a large sample of data, so I don’t want to go overboard and draw grand conclusions from this experience. But even this small sample does tell us something useful.

I put off rebalancing my long-term 50 Stocks Portfolio well beyond the traditional January deadline in 2019 because of the way market trends have played out over the these two years. In fact I didn’t rebalance this portfolio at all in 2019.

I think it’s now time to rebalance this and my other portfolios.  In this and the subsequent three posts I’ll look at some of the general principles for rebalancing and then apply those to the long-delayed rebalancing of this portfolio. (I’ll move onto other portfolios after these four posts have dealt with the 50 Stocks Portfolio.

You do remember how crazy 2018 was, right? From January 2, 2018 though the September 17, 2018 peak, the Standard & Poor’s 500 index went to a closing level of 2929.67 from 2743.5. That was a decent gain of 6.8% for the first almost nine months of the year. With that history in place, an investor wouldn’t have been delusional to image a 10% gain in the index for the year.

But then came an almost bear market. From that September 17 peak at 2929.67, the S&P 500 fell to 2416.62 at the close on December 17. That was a drop of 17.5% and led many investors, myself included, to think about the possibility of further losses and an actual bear market. (I put on bear market protection in December of that year in my Volatility Portfolio.)

But the bear wasn’t to be. From that December 17 low stocks went into a dizzying rally. By April 29, 2019 the index had rebounded to 2945, gaining 529 points from the December low and tacking on a startling 21.9%.

So what would have happened to your portfolio gains if you had, following tradition, rebalanced positions in January to take profits in winners and put new cash to work in laggards. Let’s look at Apple (AAPL) as an example over 2018 and 2019 to date.

On January 2, 2018 Apple traded at $157.74. And then it went on a tear. By September 17, 2018, the high point for the S&P 500 that year, Apple was trading at $220.70.

And then came the almost bear. By December 17, the bear bottom on the S&P 500, Apple shares were down to $163.94, a scant $6.20 a share above where they had started the year. Unlike the S&P 500 Apple continued to drop in the last days of 2018, hitting $157.92 on January 2, 2019, just abut where they’d been on January 2, 2018.

By April 29, Apple shares were back up to $204.30, almost where they’d been at the September 18, 2018 high for the S&P 500. They closed at $293.65 on December 31, 2019.

Now if you’d sold on January 2, 2019, the start of the new year for the markets, you would have lost that stunning $135.73 a share, an 85.9% gain, in Apple shares in 2019.  Woof.

But rebalancing doesn’t work like that. You would have sold on January 2, 2019 taking an 18 cents a share gain from the January 2, 2018 price. And then you would have re-invested $10,000 (each position in the long-term 50 Stocks Portfolio starts off with a weight of $10,000) and ridden that position call the way back up to $293.65.

You would have owned 63.32 shares of Apple after the rebalancing since your $10,000 would have bought you slightly fewer shares than you bought back in January 2, 2018, at $157.74 (63.40 shares). But the difference is hardly significant. Holding for the full 2 year period without rebalancing would have given you an Apple position worth $18,617 on December 31, 2019, versus the $18,593 on December 31, 2019if you had rebalanced. Add in your $11.41 profit from the January 2, 2019 rebalancing and the difference is even smaller at $18,617 without rebalancing and $18,604 with a January 2, 2019 rebalancing.

Obviously Apple is the only stock in my 50 Stocks portfolio. And 2018 and 2019 are hardly a completely representative pair of years.

But I would draw a couple of conclusions from this example.

First, with perfect 100% perfect hindsight an investor can decide to rebalance or not to rebalance in order to maximize his or her profits. But at the time? Were you absolutely certain that the almost-bear of the end of 2018 wasn’t going to turn into an actual bear? I wasn’t. I decided not to rebalance because I though the odds were against a full-on bear. But also because I bought put options that would give me some downside protection in case this was an actual bear.

Second, the effort to maximize gains from a rebalancing is only part of the story. The rebalancing of January 2, 2019, the one I didn’t actually put into practice, would have resulted in an insignificant change in the value of my portfolio as a whole. But the rebalancing might have given me significant downside protection in many situations as I took profits in my winners and bought some losers at lower prices–and sold other losing positions entirely. In effect a rebalancing might have been able to avoid some of the risk and some of the potential loss of using option insurance to protect against a downside move in the market. (Or in this case the actual loss as those put options headed south as the actual bear market didn’t materialize in early 2019.) In fact one of my tentative conclusion is that rebalancing is more useful as a risk management technique than it is as a “gain-creation” mechanism. I don’t know that I would have sold Chesapeake Energy (CHK) in a January 2019 rebalancing, but I’d like to think I would have gotten out of it. One of the advantages of rebalancing, as opposed to a standard sell/hold decision is that it forces you to ask, Would you put new money into this stock? instead of just hanging on in the hope/belief that a stock will rebound. I find it hard to believe that I would have put new money into Chesapeake, and that would have resulted in considerable savings since I would have avoided the big 2019 loss in that sock of 60.69%. (On the other hand, would I have rebalanced my way out of General Electric in January 2019 or put new money into the stock–which gained 50.07% in 2019 rising from $7.74 to close at $11.74 on December 31, 2019.

And third, the most important value in a discipline periodic rebalancing is that it forces you (me in this case) to re-evaluate every portfolio position. Do I want to put more money in the stocks have have lost ground this year because they’re going to recover in the year ahead and make me money, or is it time to cut my losses? Are the big gainers of the past you worth holding onto for another year or is it time to sell the position–not just take profits–because the trend is over? And finally, are there new names that I should be adding to this portfolio for the year ahed because they’ll make more more money than the stocks I’m selling out of the portfolio.

And with these thoughts, particularly the last one, I’m moving on to the next part of this series on rebalancing the 50 Stocks Portfolio for 2020. Part 2 tomorrow will list what stocks I’ll selling out of this portfolio for 2020.