What's the Best Way to Invest in a Rising Market?

Key Points

  • Even when the market is on a tear, it’s best to keep your emotions in check and follow a rebalancing strategy.

  • Setting tolerance bands—or percentages of movement in your portfolio that you're comfortable with—will help guide your buys and sells.

  • Rebalancing is essential, and can help protect your portfolio and make sure you stay on track during volatile times.

Dear Carrie,

My husband and I have different investing philosophies. He always wants to take some profits when the market goes up whereas I tend to want to hang on and enjoy the upswing. What do you think? – A Reader

Dear Reader,

With recent market volatility, this question couldn't be more relevant. From November through mid-March, the Dow went up 16 percent. The S&P 500 Index went up 12 percent. During these upswings, and especially as the pundits predict even higher highs, we all want to go along for the ride. It's kind of like a sugar high—the more you have, the more you want.

But it’s essential to understand that lurking beside the potential for more growth is the counter potential for a big market drop. So it's perfectly understandable that your husband would want to cash in on some profits just in case.

Your dilemma is one I think and worry about every day because—as we've all heard over and over again—you can't time the market. And if you try to, the chances of losing are just as great as your chances of winning. So, in my opinion, while you're both possibly right—you're also both possibly wrong. If the market continues to go up, it's one for your side. But if the market goes down, he's ahead.

Is there a middle ground? Absolutely. And, although it may not be that exciting, it can make all the difference.

Don't rely on emotions—rebalance

If you and your husband are experienced investors, the concept of rebalancing won't be new to you. It simply means adjusting your portfolio periodically to keep it in line with your asset allocation and risk level. But while this may be easy to understand, it can be a lot harder to do because it seems to go against human nature.

Here's an example. Let's say you're a moderate investor with ideally 60 percent in stocks. The recent market upswing has pushed your stock allocation to 80 percent. While the profits may be high—and enticing—so is your risk level. Have you all of a sudden become a more aggressive investor? If not, you really should be selling some of those high performers to bring your portfolio back in line. Sounds like your husband's approach, right?

But that's only half the equation. Because at the same time you trim back some high performing asset classes, you should evaluate your percentage in lower performing asset classes. That's the hardest part because it feels counterintuitive even though, in reality, you're selling high and buying low—exactly what every investor hopes to do.

Let the percentages guide you

One way to really take the emotion out of rebalancing is to set some parameters for your portfolio. You've probably heard differing opinions on how often to rebalance—monthly, quarterly or annually. But beyond the timing question, there's the approach of rebalancing in relation to the growth or loss in your portfolio. And that may be more helpful to you right now.

Some industry experts suggest that when an asset class grows 5 percent beyond your preferred allocation, it's time to make some sales. Likewise, if an asset class dips 5 percent below your allocation, it's time to buy. But it's up to you to set the percentage of change that you're comfortable with, often referred to as a ‘tolerance band’. This might very well be different for you and your husband.

If you're managing separate accounts, that would be no problem. You can each invest according to your own risk tolerance. If your husband has set a 5 percent limit and his stock allocation exceeds that, by all means he should sell. If you've set an 8 percent limit and your stock allocation hasn't yet reached that, you can sit tight. However, if you're managing accounts jointly, you'll have to come to some agreement.

Be diligent—and protect yourself

The challenge of rebalancing within tolerance bands is that you have to really be on top of your portfolio, and keep a careful eye out for short-term capital gains as you determine which investments to sell. In a volatile market, things can happen quickly, so you need to be diligent about following not just market ups and downs, but the real effect on your asset allocation—even down to looking at the percentage change in individual investments within each asset class.

The reward is that you'll be acting not just based on your feelings, but on real numbers. Plus, you'll be helping to protect your investments. Your profits may not be as high overall, but your potential for loss will be significantly less. To me, striking that balance is what smart, long-term investing is all about.

Here's an added bonus. By consciously rebalancing rather than just reacting, perhaps you and your husband can agree to disagree on your investing philosophies, each follow your own course—and be comfortable with your individual outcomes.

Have a personal finance question? Email us at askcarrie@schwab.com for future topic consideration.

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Important Disclosures

Investing involves risks, including loss of principal.

Diversification, automatic investing and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets.