How active do you want to be in your money management?

by Wes Bridel on February 28, 2011

in Stewardship

Is active money management a good idea?  Solomon had an interesting take…

“If clouds are full of water,
they pour rain upon the earth.
Whether a tree falls to the south or to the north,
in the place where it falls, there will it lie.

Whoever watches the wind will not plant;
whoever looks at the clouds will not reap.”
(Ecclesiastes 11:3-4)

Is it better to be an active investor or not?  Well, it depends a lot on you.  It is absolutely important that you are heavily involved in the construction of your portfolio as well as any and all major decisions.  However, it might not be a good idea at all to be constantly fiddling with your asset allocation.

Perhaps this is what Solomon is getting at in the verse 4 above.  If a farmer is constantly worrying about the weather, he won’t get around to planting and harvesting his crop.  If you as an investor are constantly trying to change your allocation in order to time the market, there’s a very good chance that your timing will be wrong and that your portfolio will shrink rather than grow.

Market Timers almost always get it wrong.  One of the reasons for this is that the right move is almost always the counter intuitive one.  And most often goes against every bone in your body.  The right move is usually the hardest one to make while the wrong move is usually the one which seems most obvious and easy.

For example, in March of 2009 the market had been plummeting for months.  Investors everywhere were panicked.  Most investors had put money in the market had a higher point and were now yanking their money out at a loss.  So for most of them, trying to time the market was the worst possible thing.

However, some people are very good at it.  This usually comes with years of disciplined and focused practice.  We follow some market timers who very accurately predicted the bottom of the market and moved in at exactly the right time in March of 2009.  They were rewarded with appreciation of 80% over the next year!

It is easy to look back and see how obvious the move was.  But at the time, the easy move was to take money out of the market.  It was gut wrenching to throw money into a market which had been falling so fast and hard.  You can see why timing the market can be quite difficult!

But again, some people are very good at it.  You must decide what your approach will be.  Will you try to actively shift your allocation depending on what is happening in the markets (while not forgetting the main principle of diversification)?  Or will you set up your allocation and only revisit it once a year or so to determine that it is still the right mix &/or to adjust your positions back to the original allocation.

Adjusting your holdings becomes necessary from time to time because you will have some holdings which shrink in value and others which grow.  This changes your original allocation.  As long as the winds of the market stay the way they are, this is probably good.  The moment they shift, you will not want to see your largest position reverse.

So choose a regular time or percentage at which you will readjust your holdings back to the original (or some newly determined) allocation.

For instance, if you have 4 holdings at 25% each, you may decide not to mess with them until one of them reaches 35%.  At that point, you may sell the gainers and buy the losers so that you are back to your original allocation of 4 assets at 25% each.

Or you might predetermine that once a year you will adjust everything back to 25% each.  Some choose to do this every year and a half.

Someone with a bent towards market timing might decide not to do this automatically, but instead to do it when it feels like the market is due for a shift (or has just begun to shift).  Again, we will warn you that this is a dangerous game to play.  If you are going to do this, you should probably practice for a couple years with a smaller amount of your overall portfolio so that you can learn the skills, patience, and discipline necessary to this art.

This is Part 4 in a series on asset allocation and diversification.  You can follow the links to read Pt 1, Pt 2, or Pt 3.

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