Can you outperform [an index by rebalancing]?

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Redstorm
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Can you outperform [an index by rebalancing]?

Post by Redstorm »

I cannot see if it's posted here however, can you outperform the index?

Say you have a three (or four) fund portfolio and invest into it regularly, rebalancing quarterly by adding new money to any lagging index, then over time will you outperform that index given that you have been buying when it has been at a lower points over time and getting a greater return?
livesoft
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Re: Can you outperform?

Post by livesoft »

Hmmm. I dunno, but I have outperformed the YTD return of VWO this year by owning VWO and rebalancing in and out of it. I don't think rebalancing quarterly is going to do it though.
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RadAudit
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Re: Can you outperform?

Post by RadAudit »

I don't know. But that is one way to play the game. And the outcome should be pretty good - even if you don't outperform the index.

(A similar approach seemed to have worked for me over the last twenty five years or so.)

Best of luck.
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tetractys
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Re: Can you outperform?

Post by tetractys »

This is the idea of using bands, an aid to buying low and selling high when called for. It's worked for me. It's been refuted by some on this forum; but without realtime proof, only speculative and, I dare say, short sighted theory. -- Tet
Rodc
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Re: Can you outperform?

Post by Rodc »

Might you? Yes. Will you? Maybe not.

Basically you are asking about a rebalance bonus. You might do a search on that term on this site.

It all hinges on whether returns are totally random or if they mean revert. Historically sometimes they do and some times they don't.

At any rate, the effect if you get it is likely to be small.
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pkcrafter
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Re: Can you outperform?

Post by pkcrafter »

Redstorm wrote:I cannot see if it's posted here however, can you outperform the index?

Say you have a three (or four) fund portfolio and invest into it regularly, rebalancing quarterly by adding new money to any lagging index, then over time will you outperform that index given that you have been buying when it has been at a lower points over time and getting a greater return?
What index? What are the 3-4 funds? :happy

Paul
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toto238
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Re: Can you outperform?

Post by toto238 »

There is one theory that might be interesting to consider.

When there is a major market crash, there is often times other macroeconomic stresses occuring at the same time. For instance, during 2007-09, unemployment skyrocketed and many people became underwater on their homes. There was a not-insignificant portion of people that sold out of the stock market, not due to fear, but due to necessity. They lost their jobs and needed to make ends meet, so they cannibalized their savings, despite the market being at cyclical lows.

So even if all players in the stock market were acting completely rationally during that financial crisis, people who should've bought (or held) ended up selling. This wasn't irrational of them. The alternative may have been starvation. All this extra selling would've pushed the prices of stocks down below their intrinsic value. Those that remained in the stock market, or rebalanced to increase their stock holdings, or bought more stocks, would've been benefitted from those that bailed out unwillingly being forced to sell at less than they would've liked.

With that in mind, it is possible that by being someone who DIDN'T lose their job during the recession, or had enough emergency funds that you did not have to sell, you were able to rebalance, or continue making contributions, that took advantage of the fact that many players in the market sold out when they would've liked to stay in.

So you would end up outperforming the index not because you were some kind of genius, but because you were not struck by a major financial shock and you had the discipline to follow your investment plan.
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sdsailing
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Re: Can you outperform?

Post by sdsailing »

It seems you are asking if you will outperform the lagging index (worst performing of the four). But why is this important ?

What would be more interesting is whether you outperform the weighted average of the four indexes (one per fund) in your portfolio.
The Wizard
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Re: Can you outperform?

Post by The Wizard »

pkcrafter wrote:
Redstorm wrote:I cannot see if it's posted here however, can you outperform the index?

Say you have a three (or four) fund portfolio and invest into it regularly, rebalancing quarterly by adding new money to any lagging index, then over time will you outperform that index given that you have been buying when it has been at a lower points over time and getting a greater return?
What index? What are the 3-4 funds? :happy

Paul
Hardly matters, but the more volatile the better.
So put $100K into the Extended Market index fund and another $100K into total bond.
Then rebalance with either 1% or 2% bands.
Should be easy to verify a small rebalancing bonus vs buy & hold...
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Compound
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Re: Can you outperform?

Post by Compound »

Seems to me that whatever time point you stop and look at your results, all of your shares will be at the current nav of the funds you own. In other words you will not have outperformed the nav (and therefore index, assuming no tracking error). What you may have done is instead bought at a lower nav than you would have had you simply purchased the funds according to your fixed asset allocation and rebalanced at a later time (i.e. not rebalanced with new money, rather bought 80/20 stock/bond or whatever you desire the overall asset allocation to be).

However, I don't think there is great consensus on how often rebalancing should be done to maximize returns. Should it be done quarterly with new money as the OP's question suggests? Annually? Biannually? Otherwise? I don't think anyone can predict which strategy will be optimal going forward. Hence, I don't think you can reliably predict a rebalancing strategy that will result in the best portfolio performance.
grossbg
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Re: Can you outperform?

Post by grossbg »

Why not divide the stock portion of a 3 fund portfolio into 33% Large cap index (VLCAX) / 33% Mid cap index (VIMAX) / and 33% Small cap index VSMAX and contribute to the fund doing the worst rather than using TSM (VTSAX). Or maybe 3 large/mid/small growth indexes? Or 3 large/mid/small value indexes? Or 6 sector specific growth and value funds covering the entire market? If we all believe the total stock market goes up in time wouldn't this be a more efficient and effective way to get a better return on stocks?

The only drawbacks I can think of might be...

1. More hands on trying to find the fund that is lacking.
2.TSM (VTSAX) has a slightly lower expense ratio of .05 compared to the above 3 at .09
3. A tad bit less sleep at night.

Someone please slap me if I am getting silly.
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Redstorm
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Re: Can you outperform [an index by rebalancing]?

Post by Redstorm »

Thanks all, some interesting posts and viewpoints above

Looking at an example of say the below which is an ASX200 fund (Vanguards Australian Index fund is an ASX300 fund) and compared to Vanguards Bond Index (VGB - the red line) the ASX200 fund is nearly back to where it started over 12 months ago, however if you had been investing in it along the way (Dollar Cost Averaging, or Value Cost Averaging) then on the times that you purchased below "zero" on the line, then surely by years end those purchases would be above zero as the cost base was lower ?

Image
Rodc
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Re: Can you outperform [an index by rebalancing]?

Post by Rodc »

Redstorm wrote:Thanks all, some interesting posts and viewpoints above

Looking at an example of say the below which is an ASX200 fund (Vanguards Australian Index fund is an ASX300 fund) and compared to Vanguards Bond Index (VGB - the red line) the ASX200 fund is nearly back to where it started over 12 months ago, however if you had been investing in it along the way (Dollar Cost Averaging, or Value Cost Averaging) then on the times that you purchased below "zero" on the line, then surely by years end those purchases would be above zero as the cost base was lower ?

Image
There will always be periods where rebalancing helps and others where rebalancing hurts. The question is will it help or hurt and by how much, long term going forwards not backwards.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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