This quote by Warren Buffet highlights the powerful role emotions can play in investing. When markets rise, optimism often follows, encouraging investors to pursue recent winners or take on more risk than they originally intended. When markets decline, fear can lead investors to sell at depressed prices or, worse, abandon a carefully constructed financial plan.
The takeaway is not that investors should buy whenever markets fall or sell whenever they rise. Rather, periods of extreme optimism or pessimism may call for greater discipline. Investment decisions should be anchored to long-term goals, risk tolerance, and time horizons rather than short-term market sentiment.
Understanding Volatility
Volatility is an inherent feature of markets. It measures how much an investment’s value moves over time and reflects investors’ reaction to changes in interest rates, economic growth, earnings, inflation, and geopolitical events.
While volatility is often associated with market declines, it can cut both ways. For example, a long market rally can alter a portfolio’s risk profile, leaving it vulnerable to larger drawdowns. If stocks outpace bonds for long enough, the allocation to stocks will increase, drifting the portfolio away from the original risk profile. In other words, without taking any deliberate action, investors may take on more risk than originally planned.
Beyond shifting a portfolio’s risk, volatility can also amplify emotional reactions. It can induce a sell response when markets fall and buy response when prices climb, ultimately resulting in buying high and selling low. Because market turning points are obvious only in hindsight, an investor who sells during a downturn has to time two decisions correctly: when to sell and when to buy back in. Getting either wrong can hurt long-term performance.
The Cost of Poorly Timed Trades
One way to measure the effect of poorly timed trades is to compare the return an investor earns while moving in and out of a fund (mutual fund or ETF) with the return of simply buying and holding that fund.
Morningstar (20261) found that over the 10 years ending December 31, 2025, the average investor earned less than the funds they invested in by 1.2 percentage points a year, or roughly 26 percentage points cumulatively. This stems from the timing and size of investor transactions, meaning investors are moving money in and out of investments at the wrong times.
The report further suggested that the gap widened in more volatile investments. Investors typically captured less of their funds’ returns, as large price swings pull attention towards recent performance and away from long-term plans.
Portfolio Rebalancing: A Disciplined Approach to Preserving Investment Goals
Portfolio rebalancing requires investors to monitor investment allocations, occasionally bringing the asset mix back to original targets. This may mean trimming investments that have performed well, or directing portfolio income and new contributions toward investments that have lagged. For instance, if a portfolio of 60% stocks and 40% bonds becomes 70% stocks and 30% bonds after a stock market rally, rebalancing would mean selling stocks or steering new contributions, dividends, and other portfolio income toward bonds.
Selling winners to add to laggards can seem counterintuitive. However, if the goal is to manage risk, an investor should aim to avoid market timing and emotionally driven trades. The value lies in setting the rules before emotions are tested. Rather than reacting to headlines or guessing where the market is headed, the investor follows a policy tied to a long-term plan.
How to Rebalance
There are several ways to rebalance.
Calendar-based rebalancing: The portfolio is reviewed and rebalanced at set intervals, such as quarterly or annually. This approach is intuitive but can trigger trades without much of a drift in the portfolio.
Threshold-based rebalancing: Think of it like setting up guard rails of when you would rebalance. The portfolio is rebalanced once an allocation goes beyond a set band. For example, an investor with a 60% equity target and a 5% band would consider rebalancing the portfolio if equities rise above 65% or fall below 55%.
Calendar-and Threshold-based rebalancing: In this hybrid approach, the portfolio is reviewed on a set schedule but rebalanced only if an asset class has drifted beyond its permitted band. This way, the portfolio can be reviewed without triggering an automatic trade which may help avoid unnecessary activity.
Key Considerations
Rebalancing can have tax consequences; so, it is best to consult a tax professional alongside your financial advisor to help plan accordingly. Investors may reduce the tax impact by directing portfolio income or new money to underweight asset classes, or making changes inside tax-advantaged accounts. Additionally, rebalancing can result in transaction costs, which should be considered when determining how frequently to rebalance.
After all, market volatility is inevitable, but an emotional response to it doesn’t have to be. An appropriate rebalancing strategy can help investors stay disciplined and manage risk while keeping their portfolios aligned with their long-term goals.
