Why We Don’t Rebalance
by Jason Hsu
For investors, the $1 million question is, “Why don’t all of us rebalance?”
Research shows compellingly the long-term benefit of rebalancing, yet anecdotal evidence suggests that most investors do not rebalance their portfolios—that is, buy assets that have become cheap and sell assets that have become expensive. In fact, many investors do the exact opposite!
Why is it so hard for investors to rebalance? The answer is less about “behavioral mistakes” than the fact that “rational” individuals care more about other things than simply maximizing investment returns. Perfectly rational individuals exhibit changing risk aversion that makes it hard for them to rebalance into high return assets that have suffered steep recent price declines. The unwillingness to buy low and sell high is not characteristic of just individual investors who are unaware of the finance literature and market history. Very sophisticated institutional investors, advised by investment consultants and academics, are prone to the very same behavior.
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