Solving the Seller's Dilemma

As difficult as it can be to make the decision to buy an investment, it's often much harder to decide when to sell. If a stock is on an extended run upward, the common temptation is to let it run.

But once that same stock begins to lose value, another common emotion kicks in -- hope. Hope that it will turn around soon. Yet all too often, the result is that you hold on to the stock until it incurs such deep losses that you finally give up on it. In fact, "waiting to break even" on a stock is one of the most frequent explanations for losses.

Rebalancing solves this dilemma but requires a strategic asset allocation plan. You then know when and what to sell when market forces cause your portfolio to move away from your asset allocation. You sell some of the assets that have grown to take up too large a share of your portfolio, using the proceeds to buy assets that have decreased from their intended size.

If you like theoretical principles, the idea makes intellectual sense. But the real benefit is that through this discipline, you capture gains that might slip away and use the proceeds to buy other investments when their prices are cheap. In short, in a calm and deliberate way, you sell what's currently high in price and buy what's low.

Time to Buy Stocks?

Even with the recent gains in the stock market, most portfolios have still suffered losses over the past couple of years in stocks. Thus, stocks likely will represent a smaller portion of your portfolio than originally intended. If that's true, then the principle of rebalancing requires selling some bonds, using those proceeds to buy more stocks.

There are several ways to execute a rebalancing strategy. You can sell your worst performers, sell a percentage of your best performers, or cut your holdings across the board. As for timing, you can decide to rebalance according to a calendar date, such as annually or every quarter, or when your positions get distorted by a specific percentage, such as 5% to 10%.