In total over the 51 years there has been a 0.37% annualized benefit - assuming zero costs for rebalancing.
boggler wrote:For those that do believe there is a rebalancing bonus, how do you justify it?
But what happens when your 'safe' asset class has outperformed, and now overpowers your portfolio? Rebalancing will not reduce risk because you are INCREASING the risky asset class.
staythecourse wrote:The fact remains is OVER time there is NO way a riskier asset class will underperform a safe asset class.
"Is this actually true? Probably."William J. Bernstein wrote:Is there any reason to believe that, on average, rebalancing will help more than it hurts? Not if we believe that market movements are random. After all, we rebalance with the hope that an asset with past higher/lower than average returns will have future lower/higher than average returns.
Is this actually true? Probably. Recall that over short periods of time asset classes display momentum, but that over periods of time over a year or longer tend to mean-revert....
Rebalance your portfolio approximately once every few years; more than once per year is probably too often. In taxable portfolios, do so even less frequently.
I don't have time to look at it now, the arithmetic/geometric thing makes my head spin and it always takes an hour to clear it, but I'm almost sure you're wrong. Every time I've looked at it before, any apparent rebalancing bonus from random series always turned out involve a smuggled-in mean reversion assumption.rmelvey wrote:nisi,
Look at the link that I posted earlier. There is no mean reversion in that example but there is a positive effect associated with rebalancing. It's an issue of arithmetic versus geometric returns. Mean reversion can certainly help, but it is not a necessary condition for rebalancing to boost returns.
Well, in fact I tried that experiment in real life and it didn't work. That is to say, I derived no advantage from having been in Balanced Index through 2008-2009 versus being in unrebalanced separate holdings of Total Stock and Total Bond. If you look at growth chart for Balanced Index Fund and select a day before and a day after 2008-2009 in which the starting and points are as close to equal as possible, and then calculate the final value for an unrebalanced mix that started as 60% Total Stock, 40% Total Bond, the difference (on a $10,000 investment) is less than $60.Blues wrote:Larry Swedroe has written on this site a couple of times that in the absence of "frictions" (taxes, costs) that rebalancing daily would be the optimal strategy....
Overall, diversifying and rebalancing is a valu- able discipline and can be used to exploit volatility. Theoretically, rebalancing reduces concentration risk, downside risk, and volatility, while increasing the long- term growth rate of the portfolio. In practice, it creates a contrarian trading pattern that trades against natural investor tendencies and takes advantage of volatility, reversals, and other return characteristics.
nisiprius wrote:Well, in fact I tried that experiment in real life and it didn't work. That is to say, I derived no advantage from having been in Balanced Index through 2008-2009 versus being in unrebalanced separate holdings of Total Stock and Total Bond. If you look at growth chart for Balanced Index Fund and select a day before and a day after 2008-2009 in which the starting and points are as close to equal as possible, and then calculate the final value for an unrebalanced mix that started as 60% Total Stock, 40% Total Bond, the difference (on a $10,000 investment) is less than $60.Blues wrote:Larry Swedroe has written on this site a couple of times that in the absence of "frictions" (taxes, costs) that rebalancing daily would be the optimal strategy....
boggler wrote:This is the best analysis I've seen of the rebalancing bonus.
http://www.iinews.com/site/pdfs/JWM_Fal ... metric.pdfOverall, diversifying and rebalancing is a valu- able discipline and can be used to exploit volatility. Theoretically, rebalancing reduces concentration risk, downside risk, and volatility, while increasing the long- term growth rate of the portfolio. In practice, it creates a contrarian trading pattern that trades against natural investor tendencies and takes advantage of volatility, reversals, and other return characteristics.
Basically, the "bonus" relies upon the assumption that the markets are mean-reverting. If they are, then buying low and selling high works, otherwise, it doesn't.
rmelvey wrote:boggler wrote:This is the best analysis I've seen of the rebalancing bonus.
http://www.iinews.com/site/pdfs/JWM_Fal ... metric.pdfOverall, diversifying and rebalancing is a valu- able discipline and can be used to exploit volatility. Theoretically, rebalancing reduces concentration risk, downside risk, and volatility, while increasing the long- term growth rate of the portfolio. In practice, it creates a contrarian trading pattern that trades against natural investor tendencies and takes advantage of volatility, reversals, and other return characteristics.
Basically, the "bonus" relies upon the assumption that the markets are mean-reverting. If they are, then buying low and selling high works, otherwise, it doesn't.
I don't understand how the coin flip example is "mean reverting" though. Each event is totally independent of prior moves in that experiment.
The intuition is that volatility creates a drag on average arithmetic returns, lowering the realized geometric average returns. Diversification and rebalancing lowers volatility, reducing the drag, therefore increasing the realized geometric average returns.
How come every time I try to explain this on the forum everyone treats me like a crazy person
rmelvey wrote:Rebalancing brings your portfolio's geometric return closer to the weighted average arithmetic return of its components. Momentum need not have anything to do with it. It is a function of diversification reducing steep losses, which we all know kills compounding.
I made a post awhile ago that shows it using an extreme example devised by Claude Shannon:
http://www.stableinvesting.com/2013/04/ ... demon.html
This example is interesting because obviously there is no momentum. Also there is no "buy low" and "sell high" because valuations have nothing to do with random coin flips. The real takeaway is that the individual coin flip games have a positive expected arithmetic return, but a an expected geometric return of 0. However, diversification can help close the gap between the arithmetic and geometric returns.
rmelvey wrote:The coin flip game has an average arithmetic return of 25%
Epsilon Delta wrote:rmelvey wrote:The coin flip game has an average arithmetic return of 25%
Let me repeat myself. What are you averaging? And I will probably add why should I care about that particular statistic? The final distribution always has zero expected return, your just rearranging the tails.
No one reduced risk by exchanging debt for more stocks at 2008's year end - a time when stocks were the most risky they have been in a living memory.
nisiprius wrote:rmelvey: I've figured out to my satisfaction, but probably not yours, why your "Shannon's Demon" example is misleading.
bmdaniel wrote:You can decide for yourself if there's a rebalancing bonus and which portfolio you would prefer. If anyone would like the spreadsheet, just pm me I will send.
bmdaniel wrote:nisiprius wrote:rmelvey: I've figured out to my satisfaction, but probably not yours, why your "Shannon's Demon" example is misleading.
Nisiprius -
You are fundamentally missing the Shannon/Kelly point around geometric vs. arithmetic returns. Yes, betting the whole amount has the highest arithmetic return - but look at your distribution of returns (just after four flips!) - only 5 of 16 "portfolios" have any gain whatsoever. The "rebalancing bonus" is that if you bet 50%, you will have a much lower standard deviation, better sharpe ratio, and much better results across a broad range of outcomes (vs. your case that depends on one unlikely outcomes for the vast majority of the return). This is easy to model in excel - I've built a spreadsheet that does 10,000 trials of a 200 flip game (just completely random "coinflips", no mean reversion). The results are below:
You can decide for yourself if there's a rebalancing bonus and which portfolio you would prefer. If anyone would like the spreadsheet, just pm me I will send.
baw703916 wrote:
But is the assumption of memory-less financial markets reasonable?
Look, someone had better state clearly and unambiguously what the proposition is, because what tends to happen these discussions is that different advocates of rebalancing put forward different claims for what it is supposed to be doing, never quite clearly stated.bmdaniel wrote:nisiprius wrote:rmelvey: I've figured out to my satisfaction, but probably not yours, why your "Shannon's Demon" example is misleading.
Nisiprius -
You are fundamentally missing the Shannon/Kelly point around geometric vs. arithmetic returns....
LadyGeek wrote:The file is 84.6 MB. Even with recalculation disabled, it's taking far too long to load and I ended up aborting. Can you reduce the size, such as putting the number of coin flips in a cell, setting it to 1, then let me change it to 2e6? I'm using LibreOffice Calc, but that shouldn't matter.
I'd still like you to state, with precision, what it is that you think rebalancing accomplishes, in the absence of mean reversion. I do not mean that it does nothing. I want a correct description of what it does do.bmdaniel wrote:I agree, as I mentioned above that it's not particularly applicable to re-balancing massive market wide index funds, because you are getting so much rebalancing underneath as well that the majority of the "risk of ruin" is already removed. If you were putting on a handful of particular trades/investments, it's more likely to be meaningful. However, I'm not convinced that it wont be a bit more broadly applicable than that (see my comment in the commodity thread, for example).
That said, I think it's a bit disingenuous to say it's just a "reshaping" to go from a distribution where you have a ~50% chance of making nothing to a distribution with an almost certainty of making money for a minuscule reduction in average return. It's basically the St. Petersburg paradox - you are not going to pay a million dollars to play, even though your expected return would be essentially infinite. If you want a really well-done concise description of the issue, I highly recommend Fortune's Formula by William Poundstone.
We see stock market charts. Our eye draws the line from the starting point to the ending point. We notice that the chart goes up and down, but eventually it always comes back to that nice straight line in the middle of all the jagged ups and downs. Our common sense mistakenly calls this "mean reversion," and we think we are seeing something significant, when what we are really seeing is just a useless triviality (what we are seeing is an immediate consequence of the definition of "average" - if you take an average of things, some of the things are above the average, and some are below, and that information is not of much significance or use).
boggler wrote:I have seen arguments that rebalancing does have a bonus if the market exhibits momentum, but I'm not sure how long a momentum-based strategy will last in the age of high-frequency trading. For those that do believe there is a rebalancing bonus, how do you justify it?