Basically MPT assumes that a person will build a nice pie chart with a mix between stocks and bonds and simply rebalance to the base model when things fall out of balance. In theory, this approach forces you to buy low and sell high since rebalancing would require you to sell some of your winners at high prices each year and buy more of your loosing assets which would be lower in price.
Following this approach after the great recession (crash of 2008) would have forced you to load up on stocks that had just dropped by 45% and sell some of your bonds to rebalance your mix. Makes perfect sense and sounds pretty simple, right? Well not really on the simple part because we humans tend to be very emotional when things go wrong and we feel much more comfortable sticking with the herd (selling low) than going against the herd and buying low.
Now maybe things might be different if you were a professional investor and ran portfolios for a living and managed other people’s money, right? Wrong! It turns out that even the best professional investors on the planet have trouble following Wall Street’s sacred buy, hold and rebalance approach and a recent article in the Wall Street Journal makes the case.
The good news is thanks to modern technology and computers, there are now ways to avoid the next freight train in the face while still participating in some of the upside when things are going well. And although Wall Street would like you to believe that you can’t beat the market, and your best bet is to stay in forever (forever paying fees…hmmm), the modern world has proven that there are much more modern approaches than MPT that no one ever dreamed were possible even 10 years ago.
So don’t feel bad if you have not been “all in” during this last stock market move because even the best professionals in the world missed most of the rally.
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