GregLee wrote:Yes, I understand that that is why you do it. That's what is going on in your head when you rebalance -- your intent is to manage your risk. But we might also be interested in the objective facts about your portfolio and the market. It's not all about your personal psychology.
Overall, I am quite puzzled by this psychological tendency in modern investing. To my mind, if you sell bonds and use the money to buy stocks, e.g., you are betting that either bonds will fall or stocks will rise, and it doesn't matter how you came to that decision. Maybe your AA-rebalancing algorithm told you to do that, or you used my fly-on-the-screen method, or your dead great grandfather spoke to you emphatically in a dream. A bet is a bet. People who think they are not gambling or speculating in the market because they have a system that tells them how to bet are just fooling themselves.
The key objective fact about a portfolio is the overall asset allocation of the whole portfolio. As a somewhat extreme illustration, consider the following:
Imagine an investor named Alice, who originally put 99% of her money in stocks and 1% of her money in bonds. Then one day she sells a little bit of her stocks and buys bonds with the proceeds, and after doing so she has 98% of her money in stocks, and 2% of her money in bonds. Would it be fair to say that Alice is betting bonds will rise or stocks will fall because she sold stocks to buy bonds?
Now imagine another investor named Bob, who currently has the same amount of savings as Alice, but who started with 99% of his money in bonds and 1% of his money in stocks. Then on the very same day, he sells a little bit of his bonds and buys stocks with proceeds, and after doing so he now has 98% in bonds and 2% in stocks. Does this mean that Bob is betting stocks will rise or bonds will fall?
I would say that, if anything, it is Alice who is betting on stocks and Bob who is betting on bonds, since Alice has 49 times as much of her portfolio in stocks as Bob does. I'll also note that most of us are "betting" on stocks to the some extent, in that we consider that stocks probably have a higher expected return then bonds (though without much agreement on how much higher). If we didn't think so we'd have little if any stock investments since stocks are almost universally considered riskier than bonds (though without much agreement on how much riskier).
The rebalancer is merely moving the overall asset allocation (which is the key objective fact) back to what it originally was. Thus rebalancing is not making a bet, except to the extent that the original allocation was a bet, in which case the rebalancer is just sticking to the original bet.
Intent really only matters when you want to figure out if not rebalancing constitutes market timing. If you refrain from rebalancing because it's too much work to do so, because of transaction costs involved, or to avoid taxes, that isn't market timing since strategy doesn't involve a prediction about what the market will do at this time. However, if you avoid rebalancing because you think that the asset that recently went up has momentum behind it, that is market timing because it does involve such a prediction.
