Different market conditions require different investment strategies. Two common strategies - buy and hold and regular rebalancing (constant mix strategy) are appropriate only under certain market conditions. What are these market conditions? Let Wilfred Ling, CFA explains to you in this 3 minutes video.
If you prefer to read, the following is a transcript of the video:
The buy and hold investment strategy can be said to be a do-nothing strategy. That is to say that after purchasing your investments, you basically do nothing to it. On the other hand, a constant mix strategy means that you always maintain a fixed percentage of risky asses in your portfolio. Constant mix strategy is often called ‘rebalancing to the strategy asset allocation’. So, what are the advantages and disadvantages of both strategies?
First, let’s assume markets are in the uptrend. A buy and hold strategy does well if markets are in the uptrend. This is because as the risky assets grow in size, the proportion of risky assets gets larger and larger in percentage and thus benefit from the appreciation of the prices of the risky assets. On the other hand, a constant mix strategy imply that appreciating assets are sold off (i.e. profits are taken to buy other assets) so as to maintain the same percentage of risky assets in the portfolio. Therefore, a constant mix strategy does poorly compared to a buy and hold strategy in a bull market.
Second, let’s assume markets are in the downtrend. The buy and hold strategy’s risky assets gets smaller and smaller in terms of its percentage due to the depreciation of the risky assets’ prices. On the other hand, a constant mix strategy is forced to maintain the same percentage of risky assets during the downtrend. Hence, the constant mix strategy is worst off compared to buy and hold in a bear market.
I want you to pause and think about it. Normally a bull run or a bear run spans across a couple of years. Sometimes over 5 years. If you are a strong advocate of rebalancing, it just means your portfolio – regardless of market direction - will underperform someone else who simply does nothing! It is for this reason that many investors do not feel they benefited from the rebalancing strategy because their feeling is that their portfolios appear to have very low returns compared to simply doing nothing.
Nevertheless, the constant mix strategy does work quite well in an oscillating market. When markets are oscillating, constant mix strategy forces the investor to take profit when prices go up and buy when prices go down. On the other hand, the performance of a buy and hold strategy during an oscillating market is flat.
As it can be seen that different strategies yield different results depending on the conditions of the investment markets. If in doubt, always engage a professional investment adviser.
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