Today we’re exploring a powerful passive investing technique that helped me tremendously during this year’s bear market. It allows you to buy low and sell high automatically. No guesswork required. Like the scaling-in technique, today’s tactic also helps you use volatility to your advantage.

It’s known as rebalancing and is used by portfolio managers everywhere. Suppose when originally crafting your investment portfolio, you decide you want the following allocation because it matches your risk tolerance:

60% stocks

40% bonds

The traditional 60/40 portfolio

After building the portfolio with the appropriate amounts in each bucket, you go away. One year later, you return to see how things have changed. Over that time, stocks were booming, and bonds went bust. Your overall portfolio grew, but the mix changed. Now it looks like this:

70% stocks

30% bonds

A more risky portfolio

Due entirely to market movement, your portfolio allocations have shifted to 70% stocks and 30% bonds. And here’s the problem. It’s riskier than what you originally intended. If present trends continue, your portfolio would eventually shift to 80% stocks, 90% stocks, and so one. Maybe you reason that’s a good thing if the stock market is rising, but I assure you it’s not good. Inevitably a bear market will arrive, and with 90% of your portfolio in equities, you will lose much more than you’re comfortable with. The risk profile of a 90/10 portfolio is way different than a 60/40 one.

So what do you do when the mix deviates from your original target?

You rebalance!

In this case, you would need to sell stocks until the % drops back to 60%. And with that cash, you would buy bonds until the % rises to 40%, thus returning your allocation to the original target. You’ve effectively sold what went high while buying what went low.

Enter Oil Stocks

Here’s how this crucial technique has helped me make money back in oil stocks way, way faster. Heading into 2020, I had about 5% of one of my portfolios allocated to OIH. Since it’s undergone a 1 for 20 reverse split, I’ll use the post-split prices to avoid confusion. My original purchase was for 10.5 shares last December when the stock was at $261. The total investment was around $2,750.

Then Armageddon came to town, and OIH fell as low as $66. That’s a 75% drawdown! My $2,750 rapidly shrunk to $700. What was 5% of my portfolio quickly became around 2%.

Time to rebalance!

On March 19th, I purchased 22 more shares near $73, to re-up my allocation to 5%. In doing so, my average cost dropped from $261 to about $137. That means to recoup my losses, I now only need OIH to rebound to $137 instead of $266. That’s a HUGE difference!

Think about what that means. Because I rebalanced, I will return to breakeven at a price that is almost 50% lower than my original purchase. Here’s a visual:

Now, for a few observations.

Key Points

First, I have much more confidence rebalancing into an ETF that has virtually zero chance of going to zero then doing so in an individual stock.

Second, I will admit there was a little luck involved with buying more OIH so close to the low. But do you know what I’ve learned over time? If you have a good plan and you have the discipline to follow the plan, luck will visit you a lot more often than they trader who is winging it.

Third, it takes guts to rebalance and buy low. Most people won’t do it when the time comes, reasoning that sector will stay out of favor or that they’ll be able to nail the timing when it recovers. I prefer just to use a rule to rebalance when the percentage allocation deviates by “X,” rather than use discretion.

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