Quick Thoughts on “Rebalancing”

Generally, rebalancing means selling investments that have performed well and moving that money into investments that have performed relatively poorly. Oftentimes, investors do this to get their portfolios back to a desired allocation - 60/40 or 80/20 or 50/50 (Stocks/Bonds). While I understand how this can help maintain a desired level of risk, I also largely recognize that it can mean selling the best investments simply because they have become a larger part of a portfolio.

My philosophy is different.

When I own a truly exceptional business, I am not simply owning a stock whose price happens to be rising. I am owning a piece of a business that is generating profits, retaining those profits, and reinvesting them into the business at attractive rates of return. If the business can continue doing this successfully, I believe its underlying intrinsic value will compound over many years.

This is central to Charlie Munger's legendary quote (the same one on the front page of this website):

“The big money is not in the buying or selling, but in the waiting.”

The point, as I understand it, is not that investors should blindly hold every investment forever. Rather, when owning a wonderful business with the ability to reinvest its earnings at high rates of return, time becomes an enormous advantage. The business can continue putting capital to work, generating more earnings, and reinvesting those earnings again and again.

I believe that, over time, the market value of that business should increasingly reflect the economic value created by this compounding.

If the underlying business remains exceptional, selling simply because its weight has increased can interrupt one of the most powerful forces in investing: compounding.

Munger's philosophy can be summarized by another important idea: my greatest advantage as an investor may often be the ability to sit still. I do not need to constantly act simply because the market is moving.

If the market rises, I do not automatically believe the businesses I own have become more valuable simply because their stock prices have increased. If the market falls, I do not automatically believe those businesses have become less valuable. My focus remains on the economics of the underlying business.

This does not mean I believe a stock can never become too expensive. If the price becomes irrational relative to the intrinsic value of the business, if the economics of the business deteriorate, or if I identify a substantially better opportunity, selling can be appropriate.

But I do not want to be in the business of trying to identify the top of the market, sell to "lock in profits," and then determine when to buy back in.

I would rather own a wonderful business and allow it to compound than repeatedly interrupt that compounding because the market has moved.

As Charlie Munger suggests, sometimes the most intelligent investment decision you can make is not to do anything at all.