A sign of slumbering—or of hope?

Posted by on February 27, 2012 @ 9:50 am in Investing

A Wall Street Journal report, published on February 21, notes that small-capitalization stock prices, as measured by the Russell 2000 Index, are nearing an all-time high. But investors aren’t pouring money into small-cap stocks.

The story, “Small-cap rise is big snooze,” notes that small-cap funds have seen steady net outflows of cash, not big inflows. “Where is the love?” asks the Journal.

There’s one possible explanation that would be good news: Maybe—just maybe—investors are learning not to chase performance.

Buying something AFTER prices have moved up—or selling AFTER prices have dropped—is a particularly destructive behavior for investors. A more positive approach is to develop an asset allocation—a mix of stocks and bonds and cash—and then stick to it.

Sticking to a plan doesn’t presume that an investor should fall asleep. If one part of a portfolio has a strong move up, the “stick-to-a-plan” investor rebalances back toward his or her target asset allocation. This means that the investor adds to the laggards in a portfolio either with new cash or with proceeds from selling part of the asset that’s risen.

Rebalancing can be emotionally difficult—adding assets to “losers” and selling assets from “winners” seems counterintuitive. But it keeps the risk profile of a portfolio in line with the plan.

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