Portfolio Rebalancing...when you collect more than one thing...or Gold...or whatever

I was just on a coin collecting forum, and a fellow forum member posed the question of whether it makes sense to sell some of their collectible coins to buy gold, or even vice versa.  I gave my answer (my "two cents") and I realized that the method needed to be repeated here.  So here goes:

Suppose you believed that it was a good "investment" to buy gold and silver.  Truth be told, when you factor in inflation, gold makes a poor investment because it only goes up in price when the dollar is weak, and the dollar is only weak when inflation is present, so the net result is that it just breaks even with inflation over the long term.  But there can be short term run-ups (or crashes) in price that can significantly outpace inflation or underperform it.  (Side note:  Check out Exchange Traded Funds which trade like stocks, such as ticker symbol "DGP").

Back to our example.  If you wanted to hold gold and silver, a good way to do it might be to buy an equal dollar value of each.  For example, imagine you were to buy $1,000 worth of gold and $1,000 worth of silver.  Then you monitor the price of both.  At some point, you might see that the value of gold and silver fluctuated where you had $1,200 worth of gold and only $800 worth of silver.  If that happened, you could "rebalance" your portfolio.  This means you would bring the dollar value of each back to the original one to one (1:1) or 50%/50% ratio.  So what you'd do is sell $200 of your gold and use that money to buy $200 worth of silver.  Then you'd have $1,000 worth of each again.  Now why in the heck would you do that?  Because when Gold went up and silver went down, you'd be selling the gold at a relative high and buying silver at a relative low.  Remember...the idea is to buy low and sell high right?  Would it help?  In some cases, yes.  But remember that when you buy and sell gold and silver, you will incur transaction fees, right?  Because of that, you might not want to balance very often.

Another example.  You don't have to maintain a 1:1 or "50/50" ratio.  Suppose you decided you wanted a portfolio of 60% Gold and 40% Silver.  You could buy $100 worth every month for 10 months.  If gold and silver didn't move much, after 10 months, you'd have about $600 worth of gold and $400 worth of silver.  Now suppose they started to shift in value.  They might shift because Silver is not just a precious metal, but also an industrial metal with rising and falling demand.  (yes, gold is an industrial metal too...but to a lesser degree).  Anyway, Silver stagnates, but Gold rises.  Soon, you have $900 worth of gold and $400 worth of Silver.  At that point, you would go through the Math to figure out how much gold to sell.  Since you have a combined $1300, you should have $780 worth of gold and the rest in silver.  So you sell off $120 in gold and buy more silver. 

What else can you balance?  You could balance a portfolio of Gold and Cash in a 70% Gold/30% Cash ratio.  If Gold climbs too high, you sell gold.  If gold drops, you buy more with your cash to rebalance.  Neat, huh?

Finally, let's discuss collectibles.  It is possible to balance a portfolio of collectibles.  Some ideas:  You could balance your coin collection's value vs. a portfolio in gold.  You could balance your coin collection's value against cash.  You could balance your coin collection's value against your comicbook collection's value.  You could even balance three things....like maintain the value of your coin collection, your comicbook collection, and gold in a 40%/40%/20% ratio. 

One last thing to realize.  This rebalancing is more effective when the items in it are fluctuating up and down...rather than certain types of collectibles that will only keep moving up in fits and starts.  But this can also create a situation where you are selling winners to buy losers.  Imagine if Bill Gates decided back in the early 1980's to balance a portfolio of MicroSoft Stock and Cash in a 50%/50% ratio?  If he did that, he'd still be rich, but not nearly as much.  In fact, he'd have been over-investing in the relative "loser"...the U.S. Dollar.  Balancing a portfolio of anything can cut your gains because you're not fully invested in a winner, but it can also help set a bottom floor on losses because you don't hold through a peak.  For example, if you were balancing a portfolio of Silver and Cash back when Silver hit $50 an ounce, you would have sold some of your silver near that peak.  But on the other hand, you wouldn't have owned as much silver either because you were keeping money in cash.  Portfolio balancing creates some tough decisions!

Collector Steve