As U.S. stocks skid lower, the big question hanging in the air for many investors seemed to be: Should I sell and go to cash?
Of course, that question is always hanging over the heads of stock market investors. After all, you can’t realize a gain without selling. The only way to lock in profits on a stock holding is to sell, right?
Not entirely. Here’s the thing you need to understand about portfolio investing, as opposed to stock picking and market timing. In a portfolio, you are always selling and you are always buying.
That’s right, “passive” investing is terribly misnamed. It’s not really a set-it-and-forget-it approach to the problem of long-term investing. Rather, portfolio investing is a set-it-and-reset-it approach. Over and over.
Here’s how it works. You buy a selection of asset classes. Not individual stocks. Not specific sectors. You aren’t looking for the underappreciated gem or the quick-hit small cap that everyone else is trying to ride.
No, you buy asset classes, big broad slices of the markets in the form of index-style exchange-traded funds (ETFs). Technically, that’s the passive part. You don’t try to pick stocks at all. You buy them to own them and hold them for long periods.
You do sell, just not 100% of any given asset class. You are never zero percent in stocks. Never zero percent in real estate. Never completely out of bonds. You never go to cash.
Yes, stocks are sliding a bit year-to-date. But the portfolio investor is not concerned about this. See, he or she was selling off stocks as they rose, all through the last several years.
Those gains already have been taken, the money redistributed to other parts of the portfolio that were out of favor as U.S. stocks got all the attention. The portfolio effect is a better total return, since those disfavored asset classes are now getting their day in the sun.
All along the way, risks are limited in two important ways. One, the portfolio investor stays in the market. Rather than miss the great days when stocks really put on gains those gains are won and, thanks to rebalancing, mostly held.
Secondly, the long-term portfolio investor gets dividend payments all that time. If you sell all of your equities and go to cash, you end up losing an extra 2% bump from stock dividends. That money should be steadily reinvested and really amps up your performance over time.
Mostly, though, the portfolio approach ends the concern of selling and going to cash. If your portfolio always has the right proportion of stocks to bonds by design, you never need to panic over rising stock prices.
Rebalancing is the icing on the cake. You get appreciation, investable income from dividends, a chance to realize gains programmatically and to reinvest those gains in a timely fashion. Nothing passive about that!