Many investors who meet up with their bank advisor for the annual performance & strategy discussion make a costly mistake. They look at their positions and trim the gainers, either because the percentage of the position has passed a certain threshold or because they think the stock has run too far too fast. This strategy is one that will cost performance over the long term.
Imagine you’re a seed investor or business angel and look at 200 companies, then invest in 20 of those. Every year you look at how the value of your investments has progressed based on the prevailing valuation at that time. Now with the commonly practised strategy by wealth management advisors and the stock market participants in general, you would sell the company that had gained the most and was thus considered to be overweight and therefor too much risk, when in fact it was probably the only company of the 20 that would help you finance the losses or average gains on the other 19! Imagine Google, Apple, Microsoft etc – had you kept selling and reinvesting into their sector competitors you would have been nicely diversified but nicely underperforming the market. Often companies go on a tear with market share due to innovation, patents, knowhow etc. It’s common knowledge that only small percentage of companies will grow at double digit rates over the medium-term. But exactely when a portfolio strikes a rich vein most investors will be told to sell that outperformer. It’s really difficult to convince investors to stick with the winners. This has negative tax effects (for companies in Switzerland) and is mainly an advantage for those banks wanting to generate trading commissions. These transaction costs are another major problem with the rebalancing strategy.
Another example: Today Nestle is worth roughly 25% of the SMI, if you had rebalanced Nestlé (which many investors do) to stay in line with maybe a 5-10% position in your portfolio you would have given up a substantial subsequent appreciation. In a portfolio I advise, the weighting has rarely been changed and the position has grown very substantially over the past 30 years. The most difficult task I encounter is keeping people from changing the winning team. Many investors want to intuitively sell the gainers, reap the ego reward and have another gamble in another stock. Most often they come to you with a stock they’ve seen discussed in newspapers or which have already seen multiyear strong growth.
They key is this: In an upward trending market, the buy and hold strategy will outperform. And the stock market over any 25 year period is upward trending. So if you’re looking to invest long term do not rebalance / reweight all the time (yearly)! The constant mix approach (rebalancing periodically) will only work if you get timing right and the markets are oscillating over the period without a trend. In graphic terms the buy and hold strategy is convex and the constant-mix strategy is concave (also see these graphs/post here I wrote back last year)