Now that we have covered portfolio construction, you need to know the basics of passive portfolio management. I will try to keep it simple, because that is really what passive portfolio management should be.
Buy and hold
When you invest in the stock market, there will be times of growth and downturns. When the market goes down, you may be tempted to sell your stocks and change your asset allocation. Don’t do it.
Passive investing is a long-term play, and time is your best friend. Let your long-term asset allocation be the only factor driving your investment decisions, not short-term market conditions.
If your life changes or portfolio objectives change, that is the only good reason to change your target asset allocation. For instance, you have a child and need to budget for college, or you change your target retirement date. These are good reasons to update your asset allocation.
But if the stock market takes a dip and you sell your equities to limit your losses and increase your asset allocation to cash and bonds, you are not likely to succeed. You are trying to time the market and that is the best way to lose money in the long run.
Don’t let your emotions take control of your investment decisions. Emotions will make you sell low and buy high. In 20 or 30 years, the current market dip will just look like a bump in the road.
Trying to time the market will negatively affect your returns
When markets go down, they don’t follow a straight line. Day traders create a lot of volatility, and you will see huge swings in opposite directions every other day. And it is impossible to predict which days the market goes up. If you miss the top days in the market, your returns will be seriously affected.
You need to buy and hold through thick and thin. It is conceptually that simple, but behaviourally difficult because you’ll be tempted to sell when the market goes down.
Just keep in mind that volatility and bear markets (periods when the markets are down 20% or more) are a recurring phenomenon and they will certainly happen, once per decade or more often. If you are investing in the long run they are completely unavoidable. But in the long term, like 10-15 years, the market always go up.
And if bear markets happen early on in your investment journey, they will allow you to buy shares of companies at discounted prices.
So just stay invested for the long term. It is the best guarantee of returns. Period.
Portfolio rebalancing
Another passive investment portfolio management tip is regularly rebalancing your asset allocation, for instance, once per year. When you have multiple asset classes in your portfolio, inevitably some will perform better than others. As a result, their percentual allocation (portfolio weight) will move accordingly.
If your asset allocation changes because some asset classes performed better than others, your portfolio may no longer reflect your desired risk-return profile. For instance, let’s say that a retiree has a target asset allocation equally split between stocks and bonds. If stocks do better than bonds, this retiree may find themselves 70% stocks and 30% bonds, which is too risky. So this person may sell 20% of the portfolio in stock and buy bonds, to return to a 50/50 portfolio allocation.
Rebalancing also enables you to sell high and buy low, because you will sell those investments that have performed well and buy those that have underperformed. It may seem counterintuitive, but this is a tried and true approach that can optimize your passive investment portfolio risk-return profile and returns in the long run.
There you go. If you got here, you learned the basics of building a passive investment portfolio and how to manage it in the long run.