Buying a stock that is experiencing massive gains may seem like a great idea. But making your investing decisions this way might not be in your best interest.
Instead, doing something that may seem counterintuitive — investing in assets that haven’t done well — could better set you up for future success. Here are three reasons why you should think about selling some of your best performing asset classes for some of your worst.
1. They’re cheaper than they were
When you are purchasing one of your worst-performing securities, you are buying something that could’ve suffered losses the year before. And this means that you would be purchasing it at a lower price than you previously could.
The table below illustrates a hypothetical of how much cheaper an investment in real estate would’ve been between 2008 and 2010 when prices were impacted by the Great Recession..
When you buy asset classes that aren’t at the top of the performance chart — like selling US investment-grade bonds and buying more stock — the transaction should be pretty straightforward. But when you are buying sectors that haven’t done so well, you should do a deeper dive.
Before loading up, ask yourself a few questions. Is it a sector that could be dying, like newspaper publishing? Or is the sector doing badly because of an isolated event, like real estate investments during the subprime crisis in 2008 or the hospitality sector in 2020 because of COVID-19? If it’s the latter, then there’s a good chance you could see it rebound in the future.
2. The worst-performing investments often become the best-performing investments
It is not uncommon that an asset class does really badly one year and very well the next year. Take for example when emerging market equity went from being the worst-performing asset class with a loss of 53.33% in 2008 to the best-performing asset class with a gain of 78.51% in 2009. Had you bought some of this sector when it was down, you could’ve experienced above-average gains.
But when making this type of transaction, you should start by considering your asset allocation model. Your portfolio should be well-diversified and have a variety of asset classes and industries rather than putting too many of your eggs into one basket.
Your buying decisions should always factor in your risk tolerances — and when you’re buying the underperforming asset class, be sure to ask yourself if it matches your account objectives well. This can help ensure that you won’t purchase too much of it, putting you into a higher risk category than you should be.
3. It rebalances your portfolio
When certain asset classes do well, they will make up a bigger portion of your overall asset allocation. So in a year when stocks perform really well , an asset allocation model made up of 70% stocks and 30% bonds may get skewed. In the next year, you may find yourself with a portfolio made up of 80% stocks and 20% bonds — which could be too risky for you and result in higher losses in the event of a stock market crash.
You could also have a scenario where bonds do well but stocks don’t, and your 70% stock and 30% bond mix becomes 60% stock and 40% bonds. In this case, your accounts could underperform, especially during times when stocks are thriving. And this type of underperformance could make meeting your goals harder.
You can rectify this change by rebalancing — or selling your winners and buying your losers. In the first scenario, you would sell 10% of stocks and reallocate the money to bonds, and in the second scenario, you would sell 10% of bonds and buy 10% of stocks.
Buying investments that are doing well might make you feel better than purchasing ones that aren’t. But nothing does well forever. Because you have no way of knowing what will do well each year, using a strategy that helps you stay evenly allocated can help you capture all of these benefits and come out on top in the long run.