Rebalancing to Oblivion

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 12:30 pm

One of my summer projects is to write our IPS. We think we can avoid selling stocks in during a bear market, and can in fact rebalance during stock declines. I described to DW what a 50% market decline might do to our (50/50) portfolio, and she was ok with the idea of rebalancing in to this size bear market. (We stuck to the plan during the great recession – but it was more accidental than intentional – we had target/balanced funds back then.) But then I described what our portfolio would be like if stocks declined another 50% - and she became uncomfortable with the idea of rebalancing again. It seems like we need a floor of bonds that we won’t go below. I think we would not be able to stick to a rebalancing plan if our portfolio dropped by much more than half.

Background: We’re teachers (mid 50’s) on the cusp of retirement and our eventual pensions will cover all our mandatory expenses (no debt). We’ll also eventually get SS. The pensions won’t cover things like long-term care, helping kids/possible grandkids, significant travel, large charitable donations, moving into a retirement community, and other niceties that our current portfolio would pay for.

So, what I’m wondering is – is our 50/50 allocation too high if we can’t stomach our portfolio dropping by much more than half? Is it reasonable to describe a point in our IPS where we stop rebalancing into stocks?

I know we can’t keep rebalancing into oblivion – so what might I do instead? How do some of you think about these issues? (This my second question to the community – I appreciate your advice.)

Dottie57
Posts: 6710
Joined: Thu May 19, 2016 5:43 pm

Re: Rebalancing to Oblivion

Post by Dottie57 » Sat Jun 22, 2019 12:39 pm

I think your rebalance plan is very reasonable. You don’t want to spend all Bonds on stocks.

dbr
Posts: 30096
Joined: Sun Mar 04, 2007 9:50 am

Re: Rebalancing to Oblivion

Post by dbr » Sat Jun 22, 2019 12:45 pm

I am perfectly comfortable for a retiree not to rebalance into stocks when stocks take a dip. Probably, however, when such a thing happens and one sells assets to take a withdrawal that sale would come from bonds, thus is "closet" rebalancing.

User avatar
vineviz
Posts: 5077
Joined: Tue May 15, 2018 1:55 pm

Re: Rebalancing to Oblivion

Post by vineviz » Sat Jun 22, 2019 12:46 pm

Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
So, what I’m wondering is – is our 50/50 allocation too high if we can’t stomach our portfolio dropping by much more than half? Is it reasonable to describe a point in our IPS where we stop rebalancing into stocks?

I know we can’t keep rebalancing into oblivion – so what might I do instead? How do some of you think about these issues? (This my second question to the community – I appreciate your advice.)
I'd find a way to get comfortable (both of you) with the concept of "rebalancing into oblivion". I use that phrase tongue-in-cheek, but rebalancing is crucial to REDUCING your risk in retirement. An emotional decision to avoid rebalancing, for any reason, is going to make your retirement riskier than it otherwise would be.

That said, you are more likely to win a Nobel Prize than live to see your 50/50 portfolio drop by 75%.

The worst 12-month return for a 50/50 portfolio was -23% (which happened in 1931).The worst 12-month return since 1940 was just -12%.

If you craft your IPS properly and can stay the course, a 50/50 portfolio should be MORE than conservative enough.

Since 1940, the worst 3-year rolling return was -1.88% and the worst 5-year rolling return was 2.82% assuming you rebalance when you are supposed to to control your risk!

Image
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 12:50 pm

Dottie57 wrote:
Sat Jun 22, 2019 12:39 pm
I think your rebalance plan is very reasonable. You don’t want to spend all Bonds on stocks.
Thank you Dottie57! It's good just to bounce my ideas off of someone and get some feedback.

User avatar
FIREchief
Posts: 3471
Joined: Fri Aug 19, 2016 6:40 pm

Re: Rebalancing to Oblivion

Post by FIREchief » Sat Jun 22, 2019 1:44 pm

Why not just cap the stocks at 50%? (i.e. rebalance when stocks exceed 50%, but just take a walk when the market plunges)
I am not a lawyer, accountant or financial advisor. Any advice or suggestions that I may provide shall be considered for entertainment purposes only.

rkhusky
Posts: 7018
Joined: Thu Aug 18, 2011 8:09 pm

Re: Rebalancing to Oblivion

Post by rkhusky » Sat Jun 22, 2019 2:20 pm

Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
So, what I’m wondering is – is our 50/50 allocation too high if we can’t stomach our portfolio dropping by much more than half? Is it reasonable to describe a point in our IPS where we stop rebalancing into stocks?
Very unlikely that a 50/50 portfolio would drop by half. As others have mentioned, try asymmetric rebalancing - keep a floor of bonds (e.g. never go below $500K of bonds) or a ceiling of stocks (e.g. never go higher than $500K in stocks). If you decide to go this route, make sure you stick with it and don't deviate because of market conditions (i.e. increase stock allocation because the outlook is rosy).

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 2:36 pm

dbr wrote:
Sat Jun 22, 2019 12:45 pm
I am perfectly comfortable for a retiree not to rebalance into stocks when stocks take a dip. Probably, however, when such a thing happens and one sells assets to take a withdrawal that sale would come from bonds, thus is "closet" rebalancing.
Thanks dbr! (I kind of do this with my RMD - take it from what's done the best.) I appreciate knowing that others feel it's ok not to be a slave to one's asset allocation.

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 2:49 pm

vineviz wrote:
Sat Jun 22, 2019 12:46 pm
I'd find a way to get comfortable (both of you) with the concept of "rebalancing into oblivion". I use that phrase tongue-in-cheek, but rebalancing is crucial to REDUCING your risk in retirement. An emotional decision to avoid rebalancing, for any reason, is going to make your retirement riskier than it otherwise would be.
I hear you. I want to be a disciplined Boglehead who sticks to the plan. I appreciate the graph and understand that based on what's happened in the past, the portfolio would do ok while maintaining that 50/50. Part of me still worries about the the small sample size (and I likely read to much apocalyptic fiction!). I also wonder if our (underfunded) pension would be maintained after a multi-year crisis. I (and DW) would feel stupid if something extraordinary did happen and the portfolio dropped by more than half. We feel so lucky to have options and don't want to lose them all. I will reflect on the idea that my trying to avoid rebalancing risk makes things riskier!

longinvest
Posts: 3811
Joined: Sat Aug 11, 2012 8:44 am

Re: Rebalancing to Oblivion

Post by longinvest » Sat Jun 22, 2019 3:05 pm

Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
It seems like we need a floor of bonds that we won’t go below. I think we would not be able to stick to a rebalancing plan if our portfolio dropped by much more than half.
OK. This doesn't stand the test of logic. Instead of setting a floor of bonds, it's best to reduce the stock allocation before the loss!

One has to decide: How much am I willing to lose in exchange for a likely possibility of superior returns? That's the basic asset allocation question.

Personally, I think that a 50% stocks loss is a good enough estimate of a bad scenario. Of course, stocks could still lose more, but if they do, it'll likely to be a Great Depression II and I'll just adapt by reducing spending. I'll still be in much better shape than those with no savings.

Two consecutive 50% losses means a 75% stock loss. This is a really dramatic loss scenario that is usually accompanied with deep societal impacts. I don't think that it would be reasonable to calibrate one's financial plan on such a catastrophic scenario. The Vanguard Total World Stock Index Fund (VTWAX) which covers the entire collection of world stock markets has a 2.0x price/book ratio. It somehow tells us that if all publicly-traded companies stopped operations tomorrow morning and were liquidated, worldwide, investors would receive (book/price) = (1 / 2.0x) = 0.5x of the current price as proceeds of selling all the assets of companies.


OK. So, let's put some math into this. Let's say that I had a $800,000 portfolio but I wouldn't like to see it drop to less than $600,000 during a 2-year period (24 months) of continuous losses with monthly rebalancing. Let's also assume that over this 2-year period, stocks cumulatively lose 50% of their value.
  • Total cumulative portfolio loss: (($600,000 / $800,000) - 1) = -25%
  • Monthly portfolio loss: (((1 - 25%)^(1 / 24)) - 1) = -1.19%
  • Monthly stocks loss: (((1 - 50%)^(1 / 24)) - 1) - -2.85%
  • Tolerable stock allocation: (-1.19% / -2.85%) = 42%
In other words, if one isn't willing lose more than quarter of a portfolio, while regularly rebalancing a portfolio (at most once a month) while stocks are losing 50% over a 2-year period, one should invest in a portfolio with 40% allocated to stocks. It's that simple.

Note that I've illustrated the worst scenario for losses: gradual monthly losses. If losses were to happen faster and in bigger increments, the portfolio would experience smaller losses. For example, if stocks were to lose their 50% in a single month, a 40/60 stocks/bonds portfolio would only lose -20% instead of -25%.
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 3:48 pm

FIREchief wrote:
Sat Jun 22, 2019 1:44 pm
Why not just cap the stocks at 50%? (i.e. rebalance when stocks exceed 50%, but just take a walk when the market plunges)
I honestly hadn't thought of that. I've always had it in mind to buy low and sell high via rebalancing, but I know there are some "FIREsales" where I would/should(?) hold onto my wallet. Thanks for a different perspective!

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 3:59 pm

rkhusky wrote:
Sat Jun 22, 2019 2:20 pm
Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
So, what I’m wondering is – is our 50/50 allocation too high if we can’t stomach our portfolio dropping by much more than half? Is it reasonable to describe a point in our IPS where we stop rebalancing into stocks?
Very unlikely that a 50/50 portfolio would drop by half. As others have mentioned, try asymmetric rebalancing - keep a floor of bonds (e.g. never go below $500K of bonds) or a ceiling of stocks (e.g. never go higher than $500K in stocks). If you decide to go this route, make sure you stick with it and don't deviate because of market conditions (i.e. increase stock allocation because the outlook is rosy).
I know it's unlikely, but I can't get the possible "Black Swan" events out of my head. I'm trying to (slightly) prepare psychologically by specifying in the IPS how we'll rebalance under normal and abnormal circumstances. I've been leaning towards the bond floor - I've never thought about the stock ceiling idea - thanks! I know we need to make our own decisions. It's interesting interesting to see the logic of those (like vineviz and longinvest) who argue differently. I need to think some more!

User avatar
Sandtrap
Posts: 8289
Joined: Sat Nov 26, 2016 6:32 pm
Location: Hawaii No Ka Oi , N. Arizona

Re: Rebalancing to Oblivion

Post by Sandtrap » Sat Jun 22, 2019 4:06 pm

Consider that there are both personal and financial "black swan" events that can dent a portfolio far more than a market downturn. So, it would be prudent to adjust your allocation and overall financial strategy to accommodate those scenarios.

A random thought.
j :happy
Wiki Bogleheads Wiki: Everything You Need to Know

dbr
Posts: 30096
Joined: Sun Mar 04, 2007 9:50 am

Re: Rebalancing to Oblivion

Post by dbr » Sat Jun 22, 2019 4:10 pm

Two points we should be clear on:

1. Proposals not to rebalance into stocks when stocks decline still include that one would rebalance out of stocks if the stock allocation gets too large. It is not the same thing as simply never rebalancing. Also the conversation probably makes more sense when we are talking about people in retirement when they are withdrawing from the portfolio. That would be from bonds if stocks are down and would tend to amount to some rebalancing.

2. The obvious counterargument to not rebalancing into stocks when stocks are down is to just hold less in stocks in the first place. In fact this rebalancing strategy probably reduces risk and reduces returns similar to just holding less in stocks. An analysis of the comparative prospects of the two choices gets to be a little bit subtle. It especially gets to be subtle if the measure of concern is survival of the portfolio under withdrawal, a result that is not very sensitive to asset allocation.

and

3. As an aside given reasonable or maybe fairly liberal rebalancing bands, rebalancing does not have a very high liklihood of being triggered at all, let alone in two successive steps. The discussion may be entirely hypothetical as well as of little practical consequence.

KlangFool
Posts: 13389
Joined: Sat Oct 11, 2008 12:35 pm

Re: Rebalancing to Oblivion

Post by KlangFool » Sat Jun 22, 2019 4:10 pm

OP,

I set my rebalancing limit at 5 years of expense. I will stop selling the bond to buy the stock when it reaches the limit of 300K.

KlangFool

longinvest
Posts: 3811
Joined: Sat Aug 11, 2012 8:44 am

Re: Rebalancing to Oblivion

Post by longinvest » Sat Jun 22, 2019 4:26 pm

dbr wrote:
Sat Jun 22, 2019 4:10 pm
2. The obvious counterargument to not rebalancing into stocks when stocks are down is to just hold less in stocks in the first place. In fact this rebalancing strategy probably reduces risk and reduces returns similar to just holding less in stocks. An analysis of the comparative prospects of the two choices gets to be a little bit subtle. It especially gets to be subtle if the measure of concern is survival of the portfolio under withdrawal, a result that is not very sensitive to asset allocation.
The idiom "portfolio survival" implies using a constant inflation-indexed portfolio withdrawal amount regardless of market returns! The problem wouldn't be the asset allocation, in this case; it would be the portfolio withdrawal method.

A lower stock allocation would naturally lead to smaller variable percentage withdrawals (which don't expose the portfolio to premature depletion) as can be seen in the VPW Table.

The same would apply during accumulation. Using a lower-stock allocation would naturally lead to higher retirement savings. The Accumulation sheet of the VPW Accumulation And Retirement Worksheet can be used to calculate this.

In other words, the trade-off of a less-volatile portfolio (e.g. lower stock allocation) and, thus, more stable spending during both accumulation and retirement, is lower overall spending.
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

User avatar
Watty
Posts: 17038
Joined: Wed Oct 10, 2007 3:55 pm

Re: Rebalancing to Oblivion

Post by Watty » Sat Jun 22, 2019 4:45 pm

Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
I know we can’t keep rebalancing into oblivion – so what might I do instead?
We have most of our money invested in a target retirement account so it rebalances automatically daily we we do not even see it. This means that we never need to make any decisions about doing a big rebalance. Any of the Lifestragety funds would do this too.

If you have money in a taxable account where the tax issues would make those funds tax inefficient then you could increase your rebalaning frequency to be quarterly or even monthly so you would be less likely to need do a big rebalance all at once.

User avatar
Raybo
Posts: 1829
Joined: Tue Feb 20, 2007 11:02 am
Location: San Francisco
Contact:

Re: Rebalancing to Oblivion

Post by Raybo » Sat Jun 22, 2019 4:56 pm

Why do you have the AA that you have? The purpose of a AA is to insure that you have the money you need to fund your retirement.

You say that your pensions and SS will fund your everyday retirement expenses and that your investments are for additional things like long term care, travel, and children/grandchildren. My question is "Do you have (what you consider) enough to fund these additional things without putting money at risk in the stock market? If so, then why have any stock, though a little is better than none at all?

There is no reason to take risk, especially if it makes you uncomfortable, if you don't need the extra money that risk might provide.
No matter how long the hill, if you keep pedaling you'll eventually get up to the top.

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 4:57 pm

Sandtrap wrote:
Sat Jun 22, 2019 4:06 pm
Consider that there are both personal and financial "black swan" events that can dent a portfolio far more than a market downturn. So, it would be prudent to adjust your allocation and overall financial strategy to accommodate those scenarios.

A random thought.
j :happy
You got that right! But does that mean I need to be aggressive and try to build the portfolio to have money for unforeseen events - like a health crisis - or does it mean to preserve the portfolio in case of a financial crisis? (That's why we settled in on a 50/50 allocation.) Thank you the reminder!

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 5:01 pm

Watty wrote:
Sat Jun 22, 2019 4:45 pm
Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
I know we can’t keep rebalancing into oblivion – so what might I do instead?
We have most of our money invested in a target retirement account so it rebalances automatically daily we we do not even see it. This means that we never need to make any decisions about doing a big rebalance. Any of the Lifestragety funds would do this too.

If you have money in a taxable account where the tax issues would make those funds tax inefficient then you could increase your rebalaning frequency to be quarterly or even monthly so you would be less likely to need do a big rebalance all at once.
Thanks Watty! Your strategy is how I got through the great recession without too much stress. As I've learned more about investing, I've sliced and diced the portfolio to make it more tax efficient - (and more complicated to rebalance). Pros and cons.

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 5:09 pm

Raybo wrote:
Sat Jun 22, 2019 4:56 pm
Why do you have the AA that you have? The purpose of a AA is to insure that you have the money you need to fund your retirement.

You say that your pensions and SS will fund your everyday retirement expenses and that your investments are for additional things like long term care, travel, and children/grandchildren. My question is "Do you have (what you consider) enough to fund these additional things without putting money at risk in the stock market? If so, then why have any stock, though a little is better than none at all?

There is no reason to take risk, especially if it makes you uncomfortable, if you don't need the extra money that risk might provide.
We picked the 50/50 allocation to balance greed and fear. We wanted to be protected from inflation, and have money for things like long term care, etc. I don't think we can do that without some stocks. It's hard to know! But you are correct that we've essentially "won the game". Actually writing out our IPS and participating in this discussion is making me think maybe my stock asset allocation might be too high. Thank you.

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sat Jun 22, 2019 5:18 pm

KlangFool wrote:
Sat Jun 22, 2019 4:10 pm
OP,

I set my rebalancing limit at 5 years of expense. I will stop selling the bond to buy the stock when it reaches the limit of 300K.

KlangFool
There's a diversity of opinion on this subject! Thanks for sharing your philosophy. I may need to revisit what my true minimum expenses are. Is self funding long-term essential or not? Helping children with grad school? A kid in crisis? That will help me set a limit like you did - or lower my stock AA. Still thinking.

longinvest
Posts: 3811
Joined: Sat Aug 11, 2012 8:44 am

Re: Rebalancing to Oblivion

Post by longinvest » Sat Jun 22, 2019 5:20 pm

Quaestner wrote:
Sat Jun 22, 2019 5:01 pm
As I've learned more about investing, I've sliced and diced the portfolio to make it more tax efficient - (and more complicated to rebalance). Pros and cons.
The more I learn, the more uncertain I grow about the alleged tax-efficiency of locating assets in various accounts.

Logically, one should apply tax adjustments to asset allocation based on asset location (see the mathematical argument in the linked wiki article), and also consider the long-term impact of putting a lower growth asset into tax advantaged accounts. After considering this (on paper), I discovered that the advantage of locating bonds in priority into tax-sheltered accounts is smaller than a simple analysis that only considers immediate savings (without making tax adjustments to asset allocation) suggests.

At the end of the day, the potential advantage seemed too uncertain to me (due to future tax and returns uncertainty). I've finally decided that I'm willing to pay the implied slightly higher overall cost of using an all-in-one investment in all accounts, including my taxable account.

Your mileage may vary.
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

Lee_WSP
Posts: 801
Joined: Fri Apr 19, 2019 5:15 pm
Location: Arizona

Re: Rebalancing to Oblivion

Post by Lee_WSP » Sat Jun 22, 2019 6:26 pm

longinvest wrote:
Sat Jun 22, 2019 3:05 pm
Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
It seems like we need a floor of bonds that we won’t go below. I think we would not be able to stick to a rebalancing plan if our portfolio dropped by much more than half.
OK. This doesn't stand the test of logic. Instead of setting a floor of bonds, it's best to reduce the stock allocation before the loss!

One has to decide: How much am I willing to lose in exchange for a likely possibility of superior returns? That's the basic asset allocation question.

Personally, I think that a 50% stocks loss is a good enough estimate of a bad scenario. Of course, stocks could still lose more, but if they do, it'll likely to be a Great Depression II and I'll just adapt by reducing spending. I'll still be in much better shape than those with no savings.

Two consecutive 50% losses means a 75% stock loss. This is a really dramatic loss scenario that is usually accompanied with deep societal impacts. I don't think that it would be reasonable to calibrate one's financial plan on such a catastrophic scenario. The Vanguard Total World Stock Index Fund (VTWAX) which covers the entire collection of world stock markets has a 2.0x price/book ratio. It somehow tells us that if all publicly-traded companies stopped operations tomorrow morning and were liquidated, worldwide, investors would receive (book/price) = (1 / 2.0x) = 0.5x of the current price as proceeds of selling all the assets of companies.


OK. So, let's put some math into this. Let's say that I had a $800,000 portfolio but I wouldn't like to see it drop to less than $600,000 during a 2-year period (24 months) of continuous losses with monthly rebalancing. Let's also assume that over this 2-year period, stocks cumulatively lose 50% of their value.
  • Total cumulative portfolio loss: (($600,000 / $800,000) - 1) = -25%
  • Monthly portfolio loss: (((1 - 25%)^(1 / 24)) - 1) = -1.19%
  • Monthly stocks loss: (((1 - 50%)^(1 / 24)) - 1) - -2.85%
  • Tolerable stock allocation: (-1.19% / -2.85%) = 42%
In other words, if one isn't willing lose more than quarter of a portfolio, while regularly rebalancing a portfolio (at most once a month) while stocks are losing 50% over a 2-year period, one should invest in a portfolio with 40% allocated to stocks. It's that simple.

Note that I've illustrated the worst scenario for losses: gradual monthly losses. If losses were to happen faster and in bigger increments, the portfolio would experience smaller losses. For example, if stocks were to lose their 50% in a single month, a 40/60 stocks/bonds portfolio would only lose -20% instead of -25%.
It could actually be worse. The book value is based on today's value of the underlying assets. If no one's willing to buy those assets, they become value less.

longinvest
Posts: 3811
Joined: Sat Aug 11, 2012 8:44 am

Re: Rebalancing to Oblivion

Post by longinvest » Sat Jun 22, 2019 6:31 pm

Lee_WSP wrote:
Sat Jun 22, 2019 6:26 pm
It could actually be worse. The book value is based on today's value of the underlying assets. If no one's willing to buy those assets, they become value less.
Yes, of course. The question is if it's reasonable to calibrate one's financial plan on a total collapse of the financial system. I was simply explaining that taking into account a potential 50% stock loss was reasonable.
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

MarkRoulo
Posts: 129
Joined: Mon Jun 22, 2015 10:25 am

Re: Rebalancing to Oblivion

Post by MarkRoulo » Sat Jun 22, 2019 6:44 pm

Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
One of my summer projects is to write our IPS. We think we can avoid selling stocks in during a bear market, and can in fact rebalance during stock declines. I described to DW what a 50% market decline might do to our (50/50) portfolio, and she was ok with the idea of rebalancing in to this size bear market. (We stuck to the plan during the great recession – but it was more accidental than intentional – we had target/balanced funds back then.) But then I described what our portfolio would be like if stocks declined another 50% - and she became uncomfortable with the idea of rebalancing again. It seems like we need a floor of bonds that we won’t go below. I think we would not be able to stick to a rebalancing plan if our portfolio dropped by much more than half.

.....

I know we can’t keep rebalancing into oblivion – so what might I do instead? How do some of you think about these issues? (This my second question to the community – I appreciate your advice.)
Your wife is correct to be concerned, but this probably only becomes an issue in extreme cases.

Of course, extreme cases are where the plan matters most.

A short summary is that buy-hold-rebalance does better than buy-hold in markets that wander back and forth. In markets that trend (either UP or DOWN) the "don't rebalance" portfolio does better. For pretty much the obvious reason.

Bill Sharpe and A. Perold discuss this in their paper "Dynamic Strategies for Asset Allocation"

It is not a crime to have as a policy that you do not sell bonds to purchase stock during stock market declines.

And if the risk you care most about is losing extra money during a big stock market decline, you haven't necessarily increased the risk you care about by failing to sell bonds and purchase stocks.

rkhusky
Posts: 7018
Joined: Thu Aug 18, 2011 8:09 pm

Re: Rebalancing to Oblivion

Post by rkhusky » Sat Jun 22, 2019 7:48 pm

Quaestner wrote:
Sat Jun 22, 2019 3:59 pm
rkhusky wrote:
Sat Jun 22, 2019 2:20 pm
Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
So, what I’m wondering is – is our 50/50 allocation too high if we can’t stomach our portfolio dropping by much more than half? Is it reasonable to describe a point in our IPS where we stop rebalancing into stocks?
Very unlikely that a 50/50 portfolio would drop by half. As others have mentioned, try asymmetric rebalancing - keep a floor of bonds (e.g. never go below $500K of bonds) or a ceiling of stocks (e.g. never go higher than $500K in stocks). If you decide to go this route, make sure you stick with it and don't deviate because of market conditions (i.e. increase stock allocation because the outlook is rosy).
I know it's unlikely, but I can't get the possible "Black Swan" events out of my head. I'm trying to (slightly) prepare psychologically by specifying in the IPS how we'll rebalance under normal and abnormal circumstances. I've been leaning towards the bond floor - I've never thought about the stock ceiling idea - thanks! I know we need to make our own decisions. It's interesting interesting to see the logic of those (like vineviz and longinvest) who argue differently. I need to think some more!
If the stock market goes to zero or the bond and stock markets drop in half, having your whole portfolio in bonds or CD's probably won't help much either. You will likely need water, survival food, a bunker, and a good supply of bullets.

magneto
Posts: 1009
Joined: Sun Dec 19, 2010 10:57 am
Location: On Chesil Beach

Re: Rebalancing to Oblivion

Post by magneto » Sun Jun 23, 2019 10:52 am

Perhaps give more thought to rebalancing technique.
Maybe take advantage of TIME as another variable.
Some suggest moving only 10% of deviation from target per month. This tends to limit the sucking effect into Stocks in a declining market and is a way of taking note of momentum when it is having an adverse effect.

By the way; try to keep IPS to less than one side of a sheet of A4.
Life is complicated enough already. :happy
'There is a tide in the affairs of men ...', Brutus (Market Timer)

Lee_WSP
Posts: 801
Joined: Fri Apr 19, 2019 5:15 pm
Location: Arizona

Re: Rebalancing to Oblivion

Post by Lee_WSP » Sun Jun 23, 2019 11:18 am

OP,
What is the current rebalance timeframe? Annually, semi annually? If you set it to semi semi annually or longer, you can avoid any historical further declines of another fifty percent.

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sun Jun 23, 2019 1:21 pm

MarkRoulo wrote:
Sat Jun 22, 2019 6:44 pm
Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
One of my summer projects is to write our IPS. We think we can avoid selling stocks in during a bear market, and can in fact rebalance during stock declines. I described to DW what a 50% market decline might do to our (50/50) portfolio, and she was ok with the idea of rebalancing in to this size bear market. (We stuck to the plan during the great recession – but it was more accidental than intentional – we had target/balanced funds back then.) But then I described what our portfolio would be like if stocks declined another 50% - and she became uncomfortable with the idea of rebalancing again. It seems like we need a floor of bonds that we won’t go below. I think we would not be able to stick to a rebalancing plan if our portfolio dropped by much more than half.

.....

I know we can’t keep rebalancing into oblivion – so what might I do instead? How do some of you think about these issues? (This my second question to the community – I appreciate your advice.)
Your wife is correct to be concerned, but this probably only becomes an issue in extreme cases.

Of course, extreme cases are where the plan matters most.

A short summary is that buy-hold-rebalance does better than buy-hold in markets that wander back and forth. In markets that trend (either UP or DOWN) the "don't rebalance" portfolio does better. For pretty much the obvious reason.

Bill Sharpe and A. Perold discuss this in their paper "Dynamic Strategies for Asset Allocation"

It is not a crime to have as a policy that you do not sell bonds to purchase stock during stock market declines.

And if the risk you care most about is losing extra money during a big stock market decline, you haven't necessarily increased the risk you care about by failing to sell bonds and purchase stocks.
Thank you for the explanation, the paper title, and the reassurance!

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sun Jun 23, 2019 1:24 pm

rkhusky wrote:
Sat Jun 22, 2019 7:48 pm
Quaestner wrote:
Sat Jun 22, 2019 3:59 pm
rkhusky wrote:
Sat Jun 22, 2019 2:20 pm
Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
So, what I’m wondering is – is our 50/50 allocation too high if we can’t stomach our portfolio dropping by much more than half? Is it reasonable to describe a point in our IPS where we stop rebalancing into stocks?
Very unlikely that a 50/50 portfolio would drop by half. As others have mentioned, try asymmetric rebalancing - keep a floor of bonds (e.g. never go below $500K of bonds) or a ceiling of stocks (e.g. never go higher than $500K in stocks). If you decide to go this route, make sure you stick with it and don't deviate because of market conditions (i.e. increase stock allocation because the outlook is rosy).
I know it's unlikely, but I can't get the possible "Black Swan" events out of my head. I'm trying to (slightly) prepare psychologically by specifying in the IPS how we'll rebalance under normal and abnormal circumstances. I've been leaning towards the bond floor - I've never thought about the stock ceiling idea - thanks! I know we need to make our own decisions. It's interesting interesting to see the logic of those (like vineviz and longinvest) who argue differently. I need to think some more!
If the stock market goes to zero or the bond and stock markets drop in half, having your whole portfolio in bonds or CD's probably won't help much either. You will likely need water, survival food, a bunker, and a good supply of bullets.
Agreed. I think I'll try to spend much more energy on trying to make society better than worrying about end of the world scenarios. I'm getting too old to fight the zombies anyway! Thank for putting things into perspective.

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sun Jun 23, 2019 1:31 pm

magneto wrote:
Sun Jun 23, 2019 10:52 am
Perhaps give more thought to rebalancing technique.
Maybe take advantage of TIME as another variable.
Some suggest moving only 10% of deviation from target per month. This tends to limit the sucking effect into Stocks in a declining market and is a way of taking note of momentum when it is having an adverse effect.
Good advice. Thank you!
magneto wrote:
Sun Jun 23, 2019 10:52 am

By the way; try to keep IPS to less than one side of a sheet of A4.

Life is complicated enough already. :happy
Ha! Too late - I failed at that! (But as I learn more, I'm becoming more inclined to keep things simple.)

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sun Jun 23, 2019 1:44 pm

Lee_WSP wrote:
Sun Jun 23, 2019 11:18 am
OP,
What is the current rebalance timeframe? Annually, semi annually? If you set it to semi semi annually or longer, you can avoid any historical further declines of another fifty percent.
Thanks for weighing in on this. Once a year I look at things very carefully for rebalancing. But... I peer at the asset allocation using portfolio watch (too) frequently and use RMDs, capital gains, dividends, and contributions to rebalance around the edges. I am leaning towards the 5/25 rebalancing rule I've read about on this forum. I suspect I'll err towards rebalancing too quickly in up markets, and too slowly in down markets.

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sun Jun 23, 2019 1:51 pm

longinvest wrote:
Sat Jun 22, 2019 3:05 pm
Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
It seems like we need a floor of bonds that we won’t go below. I think we would not be able to stick to a rebalancing plan if our portfolio dropped by much more than half.
OK. This doesn't stand the test of logic. Instead of setting a floor of bonds, it's best to reduce the stock allocation before the loss!

One has to decide: How much am I willing to lose in exchange for a likely possibility of superior returns? That's the basic asset allocation question.

Personally, I think that a 50% stocks loss is a good enough estimate of a bad scenario. Of course, stocks could still lose more, but if they do, it'll likely to be a Great Depression II and I'll just adapt by reducing spending. I'll still be in much better shape than those with no savings.

Two consecutive 50% losses means a 75% stock loss. This is a really dramatic loss scenario that is usually accompanied with deep societal impacts. I don't think that it would be reasonable to calibrate one's financial plan on such a catastrophic scenario. The Vanguard Total World Stock Index Fund (VTWAX) which covers the entire collection of world stock markets has a 2.0x price/book ratio. It somehow tells us that if all publicly-traded companies stopped operations tomorrow morning and were liquidated, worldwide, investors would receive (book/price) = (1 / 2.0x) = 0.5x of the current price as proceeds of selling all the assets of companies.


OK. So, let's put some math into this. Let's say that I had a $800,000 portfolio but I wouldn't like to see it drop to less than $600,000 during a 2-year period (24 months) of continuous losses with monthly rebalancing. Let's also assume that over this 2-year period, stocks cumulatively lose 50% of their value.
  • Total cumulative portfolio loss: (($600,000 / $800,000) - 1) = -25%
  • Monthly portfolio loss: (((1 - 25%)^(1 / 24)) - 1) = -1.19%
  • Monthly stocks loss: (((1 - 50%)^(1 / 24)) - 1) - -2.85%
  • Tolerable stock allocation: (-1.19% / -2.85%) = 42%
In other words, if one isn't willing lose more than quarter of a portfolio, while regularly rebalancing a portfolio (at most once a month) while stocks are losing 50% over a 2-year period, one should invest in a portfolio with 40% allocated to stocks. It's that simple.

Note that I've illustrated the worst scenario for losses: gradual monthly losses. If losses were to happen faster and in bigger increments, the portfolio would experience smaller losses. For example, if stocks were to lose their 50% in a single month, a 40/60 stocks/bonds portfolio would only lose -20% instead of -25%.
I very much appreciate you taking the time to show me mathematically. Dealing with mid-schoolers for 28 years hasn't done much for my quantitative skills, but I see the big picture. Your point that it's not reasonable to calibrate my financial plan on a catastrophic scenario is well taken!

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Sun Jun 23, 2019 1:57 pm

longinvest wrote:
Sat Jun 22, 2019 5:20 pm
Quaestner wrote:
Sat Jun 22, 2019 5:01 pm
As I've learned more about investing, I've sliced and diced the portfolio to make it more tax efficient - (and more complicated to rebalance). Pros and cons.
The more I learn, the more uncertain I grow about the alleged tax-efficiency of locating assets in various accounts.

Logically, one should apply tax adjustments to asset allocation based on asset location (see the mathematical argument in the linked wiki article), and also consider the long-term impact of putting a lower growth asset into tax advantaged accounts. After considering this (on paper), I discovered that the advantage of locating bonds in priority into tax-sheltered accounts is smaller than a simple analysis that only considers immediate savings (without making tax adjustments to asset allocation) suggests.

At the end of the day, the potential advantage seemed too uncertain to me (due to future tax and returns uncertainty). I've finally decided that I'm willing to pay the implied slightly higher overall cost of using an all-in-one investment in all accounts, including my taxable account.

Your mileage may vary.
Once again, you're giving me valuable food for thought. My portfolio, and learning about investing, has become kind of a hobby (and an antidote to teaching mid-school). I think I'm reaching the point where I can put things on "autopilot" and relax about the money. Writing the IPS, and reading thoughtful comments like yours have helped!

heyyou
Posts: 3537
Joined: Tue Feb 20, 2007 4:58 pm

Re: Rebalancing to Oblivion

Post by heyyou » Sun Jun 23, 2019 2:53 pm

This is just a confirmation of previous posts here: Michael H. McClung suggests a near 50/50 allocation starting retirement and to spend from bonds first, in order to avoid selling any equities during that crucial first decade of retirement, unless their growth is 120% of retirement day level. Several of your early posters directly or indirectly hinted at the same--maintaining a set amount of remaining equities, and selling from bonds during a crash.

Lee_WSP
Posts: 801
Joined: Fri Apr 19, 2019 5:15 pm
Location: Arizona

Re: Rebalancing to Oblivion

Post by Lee_WSP » Sun Jun 23, 2019 3:06 pm

Quaestner wrote:
Sun Jun 23, 2019 1:44 pm
Lee_WSP wrote:
Sun Jun 23, 2019 11:18 am
OP,
What is the current rebalance timeframe? Annually, semi annually? If you set it to semi semi annually or longer, you can avoid any historical further declines of another fifty percent.
Thanks for weighing in on this. Once a year I look at things very carefully for rebalancing. But... I peer at the asset allocation using portfolio watch (too) frequently and use RMDs, capital gains, dividends, and contributions to rebalance around the edges. I am leaning towards the 5/25 rebalancing rule I've read about on this forum. I suspect I'll err towards rebalancing too quickly in up markets, and too slowly in down markets.
Since the point of rebalancing is to limit losses by taking a haircut off gains during bull markets and to buy when equities are on sale during bear markets, that would not be the end of the world.

I agree with the other posters suggesting even less stock allocation though.

User avatar
friar1610
Posts: 1521
Joined: Sat Nov 29, 2008 9:52 pm
Location: MA South Shore

Re: Rebalancing to Oblivion

Post by friar1610 » Sun Jun 23, 2019 5:17 pm

Quaestner wrote:
Sat Jun 22, 2019 5:18 pm
KlangFool wrote:
Sat Jun 22, 2019 4:10 pm
OP,

I set my rebalancing limit at 5 years of expense. I will stop selling the bond to buy the stock when it reaches the limit of 300K.

KlangFool
There's a diversity of opinion on this subject! Thanks for sharing your philosophy. I may need to revisit what my true minimum expenses are. Is self funding long-term essential or not? Helping children with grad school? A kid in crisis? That will help me set a limit like you did - or lower my stock AA. Still thinking.
I recently had an investment advisor review our portfolio vs. our needs and goals. He helped us clarify our thinking. Our equity is now a bit less than 50% but we plan to ramp it up to the 50% level in due course (a year or so?). At 74/72 we don't envision needing to access the equities; barring the unexpected/unforeseen they will go to our kids. That will leave us with a healthy liability-matched allocation of fixed income for the other 50%. But, we have a floor of fixed income (expressed in $, not %) below which we will not go. That may mean we'll have to forego buying equities "on sale" at some point in the future if getting back to 50% equities means dropping below $X on the fixed income side. So be it. We'd rather be at, say, 30/70 for a few years than to reduce the "safe" portion of our portfolio unacceptably. We would probably see this differently if we were still in the accumulation phase but we're not so that's our plan and we're stickin' with it.
Friar1610

ronno2018
Posts: 142
Joined: Sat Apr 14, 2018 9:31 am

Re: Rebalancing to Oblivion

Post by ronno2018 » Sun Jun 23, 2019 6:25 pm

rkhusky wrote:
Sat Jun 22, 2019 7:48 pm
Quaestner wrote:
Sat Jun 22, 2019 3:59 pm
rkhusky wrote:
Sat Jun 22, 2019 2:20 pm
Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
So, what I’m wondering is – is our 50/50 allocation too high if we can’t stomach our portfolio dropping by much more than half? Is it reasonable to describe a point in our IPS where we stop rebalancing into stocks?
Very unlikely that a 50/50 portfolio would drop by half. As others have mentioned, try asymmetric rebalancing - keep a floor of bonds (e.g. never go below $500K of bonds) or a ceiling of stocks (e.g. never go higher than $500K in stocks). If you decide to go this route, make sure you stick with it and don't deviate because of market conditions (i.e. increase stock allocation because the outlook is rosy).
I know it's unlikely, but I can't get the possible "Black Swan" events out of my head. I'm trying to (slightly) prepare psychologically by specifying in the IPS how we'll rebalance under normal and abnormal circumstances. I've been leaning towards the bond floor - I've never thought about the stock ceiling idea - thanks! I know we need to make our own decisions. It's interesting interesting to see the logic of those (like vineviz and longinvest) who argue differently. I need to think some more!
If the stock market goes to zero or the bond and stock markets drop in half, having your whole portfolio in bonds or CD's probably won't help much either. You will likely need water, survival food, a bunker, and a good supply of bullets.
The zombies will get you anyway. :happy

typical.investor
Posts: 1079
Joined: Mon Jun 11, 2018 3:17 am

Re: Rebalancing to Oblivion

Post by typical.investor » Sun Jun 23, 2019 8:19 pm

Quaestner wrote:
Sat Jun 22, 2019 12:30 pm
So, what I’m wondering is – is our 50/50 allocation too high if we can’t stomach our portfolio dropping by much more than half? Is it reasonable to describe a point in our IPS where we stop rebalancing into stocks?

I know we can’t keep rebalancing into oblivion – so what might I do instead? How do some of you think about these issues? (This my second question to the community – I appreciate your advice.)
Perhaps you'd be better served not by stopping, but by delaying your start. This is as rebalancing in a crisis can lead to substantially larger drawdowns.


From Strategic Rebalancing
NICOLAS GRANGER, CAMPBELL R. HARVEY, SANDY RATTRAY, and OTTO VAN HEMERT
ABSTRACT
A mechanical rebalancing strategy, such as a monthly or quarterly reallocation towards fixed portfolio weights, is an active strategy. Winning asset classes are sold and losers are bought. During crises, when markets are often trending, this can lead to substantially larger drawdowns than a buy-and-hold strategy. Our paper shows that the negative convexity induced by rebalancing can be substantially mitigated, taking the popular 60-40 stock-bond portfolio as our use case. One alternative is an allocation to a trend-following strategy. The positive convexity of this overlay tends to counter the impact on drawdowns of the mechanical rebalancing strategy. The second alternative we call strategic rebalancing, which uses smart rebalancing timing based on trend-following signals –without a direct allocation to a trend-following strategy. For example, if the trend-following model suggests that stock markets are in a negative trend, rebalancing is delayed.
Here you can see their results from the strategic rebalancing strategy showing that if look at the 12 month market trend and wait until it turn positive, on average you will see a 3% improvement. In 2009, that was 5.6%.

Image

Also note that an annual rebalance strategy shows improvement over monthly, quarterly, 2% bands and 4% bands. Note: "full", "half" and "quarter" in the headings means how much you rebalance. So sticking to a yearly rebalancing plan and doing it fully on average is an 0.8% improvement that monthly rebalancing. Using bands only improves things if you only rebalance partially.
Image

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Tue Jun 25, 2019 4:00 pm

Thank you for this detailed information! It would appear to be bad news for all the folks in target date funds (?). I wonder how much of an art vs. a science this is (choosing your specific rule), and where you might steer someone who wanted to review recent trends for different asset classes?

longinvest
Posts: 3811
Joined: Sat Aug 11, 2012 8:44 am

Re: Rebalancing to Oblivion

Post by longinvest » Tue Jun 25, 2019 6:17 pm

The proper way to compare rebalancing approaches is to compare portfolios with an identical average allocation to stocks over the comparison period*. Rebalancing yearly usually leads to a slightly higher average allocation to stocks than the target allocation. One could achieve a similar but more consistent result with monthly rebalancing and a slightly higher target allocation to stocks.

* Most studies about rebalancing fail to do this, unfortunately.

I've written the following two post where I did a fair comparison of a monthly rebalanced portfolio and a non-rebalanced portfolio (which generalizes a slower rebalancing approach): The conclusions bear repeating:
longinvest wrote:
Tue Oct 23, 2018 7:29 am
Adding bonds to a portfolio is a risk management decision, not a return maximization strategy, and rebalancing goes along with that decision.
longinvest wrote:
Wed Oct 24, 2018 10:37 am
My point is this: There's no reason to add bonds to a portfolio if the goal isn't to manage risk. Rebalancing is part of this. Avoiding rebalancing (or not rebalancing into stocks) to reduce losses is illogical; the same loss protection can be achieved by simply choosing a higher allocation to bonds in the first place. This will, of course, reduce the potential upside of the portfolio, but it will do so consistently. A non-rebalanced portfolio reduces potential gains at the worst of times, at the bottom of a bear market, and it increases potential losses at the worst of times, at the top of a bubble; it's an illogical approach to risk management.

Losses, if too big for the investor to handle, can be reliably reduced by simply increasing the bond allocation ahead of time, instead of not rebalancing or trying to find an illusive "better" rebalancing technique.
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

Topic Author
Quaestner
Posts: 177
Joined: Tue Jul 18, 2017 6:39 pm

Re: Rebalancing to Oblivion

Post by Quaestner » Tue Jun 25, 2019 6:51 pm

Your posts mathematically show what I've understood (from reading books and thinking about this). I've always wanted to rebalance, but you give a clear explanation of why. I've been surprised at the number of people on this, and other threads, that eschew rebalancing - or only intend to do it in one direction. Maybe they aren't thinking clearly or desire a "dynamic" risk profile?

I just found a different thread "Rebalancing Yourself to Oblivion" from 2007 that has a Bogle quote echoing what you say:
anthau wrote:
Sun Jan 24, 2010 3:01 pm
In Common Sense on Mutual Funds (1999 ed.) (pp 65-66), Mr. Bogle writes:
Once you have determined a strategic long-term asset allocation, you must decide whether this balance will be fixed or dynamic. There are two principle options. You can (1) keep your strategic ratio fixed, periodically buying and selling stocks and bonds to restore your portfolio to its original allocation; or (2) set an initial allocation and then let your investment profits ride. . . .
. . . . Many investors will find greater peace of mind with a stable balance of stocks and bonds--a strategy that is counterintuitive but may prove productive--than with taking no action and allowing risk exposure to rise in tandem with the stock market--a strategy that is intuitive but may prove counterproductive.
In counterpoint, though I have yet to read it, this thread looks pertinent.
Thanks again. I think we have a good plan. Confident we can stay 50/50 through a major bear. Will not obsess about "oblivion"!

dbr
Posts: 30096
Joined: Sun Mar 04, 2007 9:50 am

Re: Rebalancing to Oblivion

Post by dbr » Wed Jun 26, 2019 9:28 am

Quaestner wrote:
Tue Jun 25, 2019 6:51 pm
Your posts mathematically show what I've understood (from reading books and thinking about this). I've always wanted to rebalance, but you give a clear explanation of why. I've been surprised at the number of people on this, and other threads, that eschew rebalancing - or only intend to do it in one direction. Maybe they aren't thinking clearly or desire a "dynamic" risk profile?

I just found a different thread "Rebalancing Yourself to Oblivion" from 2007 that has a Bogle quote echoing what you say:
anthau wrote:
Sun Jan 24, 2010 3:01 pm
In Common Sense on Mutual Funds (1999 ed.) (pp 65-66), Mr. Bogle writes:
Once you have determined a strategic long-term asset allocation, you must decide whether this balance will be fixed or dynamic. There are two principle options. You can (1) keep your strategic ratio fixed, periodically buying and selling stocks and bonds to restore your portfolio to its original allocation; or (2) set an initial allocation and then let your investment profits ride. . . .
. . . . Many investors will find greater peace of mind with a stable balance of stocks and bonds--a strategy that is counterintuitive but may prove productive--than with taking no action and allowing risk exposure to rise in tandem with the stock market--a strategy that is intuitive but may prove counterproductive.
In counterpoint, though I have yet to read it, this thread looks pertinent.
Thanks again. I think we have a good plan. Confident we can stay 50/50 through a major bear. Will not obsess about "oblivion"!
Mr. Bogle and some other commenters are citing the risk of allowing portfolios to rise to very high stock allocations over time. That is the natural result in the long run of not rebalancing. Those who might decide not to rebalance into stocks when stocks are down are not doing that and the comment is irrelevant. Whether or not one might rebalance out of stock gains but not rebalance into stock losses is a discussion. The argument to just set an asset allocation and rebalance probably has the greater weight of logic. The criticism that such a practice is risky is just not so.

longinvest
Posts: 3811
Joined: Sat Aug 11, 2012 8:44 am

Re: Rebalancing to Oblivion

Post by longinvest » Wed Jun 26, 2019 9:41 am

dbr wrote:
Wed Jun 26, 2019 9:28 am
Quaestner wrote:
Tue Jun 25, 2019 6:51 pm
Your posts mathematically show what I've understood (from reading books and thinking about this). I've always wanted to rebalance, but you give a clear explanation of why. I've been surprised at the number of people on this, and other threads, that eschew rebalancing - or only intend to do it in one direction. Maybe they aren't thinking clearly or desire a "dynamic" risk profile?

I just found a different thread "Rebalancing Yourself to Oblivion" from 2007 that has a Bogle quote echoing what you say:
anthau wrote:
Sun Jan 24, 2010 3:01 pm
In Common Sense on Mutual Funds (1999 ed.) (pp 65-66), Mr. Bogle writes:
Once you have determined a strategic long-term asset allocation, you must decide whether this balance will be fixed or dynamic. There are two principle options. You can (1) keep your strategic ratio fixed, periodically buying and selling stocks and bonds to restore your portfolio to its original allocation; or (2) set an initial allocation and then let your investment profits ride. . . .
. . . . Many investors will find greater peace of mind with a stable balance of stocks and bonds--a strategy that is counterintuitive but may prove productive--than with taking no action and allowing risk exposure to rise in tandem with the stock market--a strategy that is intuitive but may prove counterproductive.
In counterpoint, though I have yet to read it, this thread looks pertinent.
Thanks again. I think we have a good plan. Confident we can stay 50/50 through a major bear. Will not obsess about "oblivion"!
Mr. Bogle and some other commenters are citing the risk of allowing portfolios to rise to very high stock allocations over time. That is the natural result in the long run of not rebalancing. Those who might decide not to rebalance into stocks when stocks are down are not doing that and the comment is irrelevant. Whether or not one might rebalance out of stock gains but not rebalance into stock losses is a discussion. The argument to just set an asset allocation and rebalance probably has the greater weight of logic. The criticism that such a practice is risky is just not so.
I suggest to read my last post and the posts it links to.

To summarize: If one planning to not rebalance from bonds to stocks, one has too much allocated to stocks and should cut the stocks allocation now, before a future loss happens, and then go on with a normal rebalancing program. It's illogical to keep exposing the portfolio to bigger potential losses (by keeping a higher stock allocation) knowing that the investor is willing to accept smaller potential portfolio gains (as indicated by the willingness to hold a smaller and lower-stock portfolio after future portfolio losses). The time to cut the stock allocation isn't after the loss; it's now!

The mathematics and logic of rebalancing are clear. It's important for investors to logically consider future scenarios.

Emotions are misleading. They push investors to hold on a higher stock allocation when stocks do well, and a lower stock allocation when stocks do badly. That's a bad idea.
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

typical.investor
Posts: 1079
Joined: Mon Jun 11, 2018 3:17 am

Re: Rebalancing to Oblivion

Post by typical.investor » Wed Jun 26, 2019 9:48 am

longinvest wrote:
Wed Jun 26, 2019 9:41 am
To summarize: If one planning to not rebalance from bonds to stocks, one has too much allocated to stocks and should cut the stocks allocation now, before a future loss happens, and then go on with a normal rebalancing program.
I disagree.

longinvest wrote:
Wed Jun 26, 2019 9:41 am
It's illogical to keep exposing the portfolio to bigger potential losses (by keeping a higher stock allocation) knowing that the investor is willing to accept smaller potential portfolio gains (as indicated by the willingness to hold a smaller and lower-stock portfolio after future portfolio losses). The time to cut the stock allocation isn't after the loss; it's now!
No, it's not illogical.
longinvest wrote:
Wed Jun 26, 2019 9:41 am
The mathematics and logic of rebalancing are clear. It's important for investors to logically consider future scenarios.
Yes, the math is clear. Mechanically rebalancing into downturns induces negative convexity and larger drawdowns.
longinvest wrote:
Wed Jun 26, 2019 9:41 am
Emotions are misleading. They push investors to hold on a higher stock allocation when stocks do well, and a lower stock allocation when stocks do badly. That's a bad idea.
And if stocks are trending down, increasing your allocation to stocks AND needing to spend from your portfolio in retirement is worse.

viewtopic.php?f=1&t=283971&p=4611957#p4608208

longinvest
Posts: 3811
Joined: Sat Aug 11, 2012 8:44 am

Re: Rebalancing to Oblivion

Post by longinvest » Wed Jun 26, 2019 9:59 am

Dear typical.investor,

1- Your comparison table is guilty of comparing portfolios with a distinct effective average allocation to stocks. You should do a proper comparison of portfolios with equal effective average allocation to stocks.

2- Here's one of the posts I linked to that shows that keeping a higher allocation to stocks and not rebalancing into stocks after a loss is a bad idea; that it's better to reduce the stock allocation before the loss happens and then go on with the rebalancing program:
longinvest wrote:
Wed Oct 24, 2018 10:37 am
The case for rebalancing when stocks are down is all about choosing the appropriate asset allocation (AA) in the first place. Let's look at the allocation drift of a 50/50 US Stocks / US Bonds (VTI/BND) portfolio where the investor decided not to rebalance bonds into stocks during the 2008-2009 financial crisis:

Source: Portfolio Visualizer
Period: Jan 2008 - Feb 2009
Image

The AA started at 50/50 and finished at 37/63 stocks/bonds. Over the period, the average AA was 43.5/56.5 stocks/bonds. ADDED: I forgot to explain how I got this. I simply took the initial and final allocation to stocks divided by two: ((50 + 37) / 2) = 43.5.

I am saying that the investor should have chosen an AA with a higher allocation to bonds from the start, like 43.5/56.5 stocks bonds (Portfolio Visualizer), and then rebalanced his portfolio.

Here are the outcomes for the 50/50 non-rebalanced and 43.5/56.5 rebalanced portfolios:

Code: Select all

Jan 2008 - Feb 2009 (VTI/BND)
Portfolio         Initial Final   CAGR   Stdev	
50/50 (drift)     $10,000 $7,794 -19.24% 11.77%
43.5/56.5 (rebal) $10,000 $7,763 -19.51% 11.59%
Both portfolios experienced an almost identical loss with almost identical average volatility. In other words, there was no advantage to holding a 50/50 non-rebalanced portfolio over a 43.5/56.5 rebalanced portfolio over that period.

But, the market reversed its direction. If we extend the time period from Jan 2008 to Dec 2010, we can see the clear difference between the inconsistently allocated portfolio that started at 50/50 and then let the market decide of its allocation, and the consistently allocated and rebalanced 43.5/56.5 portfolio:

Code: Select all

Jan 2008 - Dec 2010 (VTI/BND)
Portfolio         Initial Final  CAGR   Stdev	
50/50 (drift)     $10,000 $10,650 2.12% 10.41%
43.5/56.5 (rebal) $10,000 $10,943 3.05% 10.78%
Almost two years after the bottom of the bear market, the annualized return (CAGR) of the 50/50 non-rebalanced portfolio was lagging behind by almost 1%, without any benefit (almost identical volatility).
3- Our philosophy is clear:

Stay the course
This is perhaps the most challenging part of Boglehead investing, but is essential to its success. Bogleheads adopt a reasonable investment plan and then stay the course. [...]
Create an asset allocation that includes bonds to reduce the volatility caused by the stock part of your portfolio, then rebalance when needed. This balanced approach will help you to stay the course. Once you set up a Boglehead portfolio, the only real course correction needed is to rebalance once per year to bring the stock/bond allocations back to pre-set levels.
Best regards,

longinvest
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

CoastalWinds
Posts: 428
Joined: Sat Apr 06, 2019 8:28 pm

Re: Rebalancing to Oblivion

Post by CoastalWinds » Mon Sep 16, 2019 10:58 am

longinvest wrote:
Wed Jun 26, 2019 9:59 am
Dear typical.investor,

1- Your comparison table is guilty of comparing portfolios with a distinct effective average allocation to stocks. You should do a proper comparison of portfolios with equal effective average allocation to stocks.

2- Here's one of the posts I linked to that shows that keeping a higher allocation to stocks and not rebalancing into stocks after a loss is a bad idea; that it's better to reduce the stock allocation before the loss happens and then go on with the rebalancing program:
longinvest wrote:
Wed Oct 24, 2018 10:37 am
The case for rebalancing when stocks are down is all about choosing the appropriate asset allocation (AA) in the first place. Let's look at the allocation drift of a 50/50 US Stocks / US Bonds (VTI/BND) portfolio where the investor decided not to rebalance bonds into stocks during the 2008-2009 financial crisis:

Source: Portfolio Visualizer
Period: Jan 2008 - Feb 2009
Image

The AA started at 50/50 and finished at 37/63 stocks/bonds. Over the period, the average AA was 43.5/56.5 stocks/bonds. ADDED: I forgot to explain how I got this. I simply took the initial and final allocation to stocks divided by two: ((50 + 37) / 2) = 43.5.

I am saying that the investor should have chosen an AA with a higher allocation to bonds from the start, like 43.5/56.5 stocks bonds (Portfolio Visualizer), and then rebalanced his portfolio.

Here are the outcomes for the 50/50 non-rebalanced and 43.5/56.5 rebalanced portfolios:

Code: Select all

Jan 2008 - Feb 2009 (VTI/BND)
Portfolio         Initial Final   CAGR   Stdev	
50/50 (drift)     $10,000 $7,794 -19.24% 11.77%
43.5/56.5 (rebal) $10,000 $7,763 -19.51% 11.59%
Both portfolios experienced an almost identical loss with almost identical average volatility. In other words, there was no advantage to holding a 50/50 non-rebalanced portfolio over a 43.5/56.5 rebalanced portfolio over that period.

But, the market reversed its direction. If we extend the time period from Jan 2008 to Dec 2010, we can see the clear difference between the inconsistently allocated portfolio that started at 50/50 and then let the market decide of its allocation, and the consistently allocated and rebalanced 43.5/56.5 portfolio:

Code: Select all

Jan 2008 - Dec 2010 (VTI/BND)
Portfolio         Initial Final  CAGR   Stdev	
50/50 (drift)     $10,000 $10,650 2.12% 10.41%
43.5/56.5 (rebal) $10,000 $10,943 3.05% 10.78%
Almost two years after the bottom of the bear market, the annualized return (CAGR) of the 50/50 non-rebalanced portfolio was lagging behind by almost 1%, without any benefit (almost identical volatility).
3- Our philosophy is clear:

Stay the course
This is perhaps the most challenging part of Boglehead investing, but is essential to its success. Bogleheads adopt a reasonable investment plan and then stay the course. [...]
Create an asset allocation that includes bonds to reduce the volatility caused by the stock part of your portfolio, then rebalance when needed. This balanced approach will help you to stay the course. Once you set up a Boglehead portfolio, the only real course correction needed is to rebalance once per year to bring the stock/bond allocations back to pre-set levels.
Best regards,

longinvest
What re-balancing strategy was used in this Portfolio Visualizer analysis?

longinvest
Posts: 3811
Joined: Sat Aug 11, 2012 8:44 am

Re: Rebalancing to Oblivion

Post by longinvest » Mon Sep 16, 2019 11:05 am

CoastalWinds wrote:
Mon Sep 16, 2019 10:58 am
longinvest wrote:
Wed Jun 26, 2019 9:59 am
Dear typical.investor,

1- Your comparison table is guilty of comparing portfolios with a distinct effective average allocation to stocks. You should do a proper comparison of portfolios with equal effective average allocation to stocks.

2- Here's one of the posts I linked to that shows that keeping a higher allocation to stocks and not rebalancing into stocks after a loss is a bad idea; that it's better to reduce the stock allocation before the loss happens and then go on with the rebalancing program:
longinvest wrote:
Wed Oct 24, 2018 10:37 am
The case for rebalancing when stocks are down is all about choosing the appropriate asset allocation (AA) in the first place. Let's look at the allocation drift of a 50/50 US Stocks / US Bonds (VTI/BND) portfolio where the investor decided not to rebalance bonds into stocks during the 2008-2009 financial crisis:

Source: Portfolio Visualizer
Period: Jan 2008 - Feb 2009
Image

The AA started at 50/50 and finished at 37/63 stocks/bonds. Over the period, the average AA was 43.5/56.5 stocks/bonds. ADDED: I forgot to explain how I got this. I simply took the initial and final allocation to stocks divided by two: ((50 + 37) / 2) = 43.5.

I am saying that the investor should have chosen an AA with a higher allocation to bonds from the start, like 43.5/56.5 stocks bonds (Portfolio Visualizer), and then rebalanced his portfolio.

Here are the outcomes for the 50/50 non-rebalanced and 43.5/56.5 rebalanced portfolios:

Code: Select all

Jan 2008 - Feb 2009 (VTI/BND)
Portfolio         Initial Final   CAGR   Stdev	
50/50 (drift)     $10,000 $7,794 -19.24% 11.77%
43.5/56.5 (rebal) $10,000 $7,763 -19.51% 11.59%
Both portfolios experienced an almost identical loss with almost identical average volatility. In other words, there was no advantage to holding a 50/50 non-rebalanced portfolio over a 43.5/56.5 rebalanced portfolio over that period.

But, the market reversed its direction. If we extend the time period from Jan 2008 to Dec 2010, we can see the clear difference between the inconsistently allocated portfolio that started at 50/50 and then let the market decide of its allocation, and the consistently allocated and rebalanced 43.5/56.5 portfolio:

Code: Select all

Jan 2008 - Dec 2010 (VTI/BND)
Portfolio         Initial Final  CAGR   Stdev	
50/50 (drift)     $10,000 $10,650 2.12% 10.41%
43.5/56.5 (rebal) $10,000 $10,943 3.05% 10.78%
Almost two years after the bottom of the bear market, the annualized return (CAGR) of the 50/50 non-rebalanced portfolio was lagging behind by almost 1%, without any benefit (almost identical volatility).
3- Our philosophy is clear:

Stay the course
This is perhaps the most challenging part of Boglehead investing, but is essential to its success. Bogleheads adopt a reasonable investment plan and then stay the course. [...]
Create an asset allocation that includes bonds to reduce the volatility caused by the stock part of your portfolio, then rebalance when needed. This balanced approach will help you to stay the course. Once you set up a Boglehead portfolio, the only real course correction needed is to rebalance once per year to bring the stock/bond allocations back to pre-set levels.
Best regards,

longinvest
What re-balancing strategy was used in this Portfolio Visualizer analysis?
The following two portfolios were compared:
  • 50/50 drifting to 37/63 stocks/bonds portfolio (no rebalancing)
  • 43.5/56.5 stocks/bonds portfolio rebalanced monthly
Bogleheads investment philosophy | single-ETF balanced portfolio | VBAL

CoastalWinds
Posts: 428
Joined: Sat Apr 06, 2019 8:28 pm

Re: Rebalancing to Oblivion

Post by CoastalWinds » Mon Sep 16, 2019 11:40 am

longinvest wrote:
Mon Sep 16, 2019 11:05 am
CoastalWinds wrote:
Mon Sep 16, 2019 10:58 am
longinvest wrote:
Wed Jun 26, 2019 9:59 am
Dear typical.investor,

1- Your comparison table is guilty of comparing portfolios with a distinct effective average allocation to stocks. You should do a proper comparison of portfolios with equal effective average allocation to stocks.

2- Here's one of the posts I linked to that shows that keeping a higher allocation to stocks and not rebalancing into stocks after a loss is a bad idea; that it's better to reduce the stock allocation before the loss happens and then go on with the rebalancing program:
longinvest wrote:
Wed Oct 24, 2018 10:37 am
The case for rebalancing when stocks are down is all about choosing the appropriate asset allocation (AA) in the first place. Let's look at the allocation drift of a 50/50 US Stocks / US Bonds (VTI/BND) portfolio where the investor decided not to rebalance bonds into stocks during the 2008-2009 financial crisis:

Source: Portfolio Visualizer
Period: Jan 2008 - Feb 2009
Image

The AA started at 50/50 and finished at 37/63 stocks/bonds. Over the period, the average AA was 43.5/56.5 stocks/bonds. ADDED: I forgot to explain how I got this. I simply took the initial and final allocation to stocks divided by two: ((50 + 37) / 2) = 43.5.

I am saying that the investor should have chosen an AA with a higher allocation to bonds from the start, like 43.5/56.5 stocks bonds (Portfolio Visualizer), and then rebalanced his portfolio.

Here are the outcomes for the 50/50 non-rebalanced and 43.5/56.5 rebalanced portfolios:

Code: Select all

Jan 2008 - Feb 2009 (VTI/BND)
Portfolio         Initial Final   CAGR   Stdev	
50/50 (drift)     $10,000 $7,794 -19.24% 11.77%
43.5/56.5 (rebal) $10,000 $7,763 -19.51% 11.59%
Both portfolios experienced an almost identical loss with almost identical average volatility. In other words, there was no advantage to holding a 50/50 non-rebalanced portfolio over a 43.5/56.5 rebalanced portfolio over that period.

But, the market reversed its direction. If we extend the time period from Jan 2008 to Dec 2010, we can see the clear difference between the inconsistently allocated portfolio that started at 50/50 and then let the market decide of its allocation, and the consistently allocated and rebalanced 43.5/56.5 portfolio:

Code: Select all

Jan 2008 - Dec 2010 (VTI/BND)
Portfolio         Initial Final  CAGR   Stdev	
50/50 (drift)     $10,000 $10,650 2.12% 10.41%
43.5/56.5 (rebal) $10,000 $10,943 3.05% 10.78%
Almost two years after the bottom of the bear market, the annualized return (CAGR) of the 50/50 non-rebalanced portfolio was lagging behind by almost 1%, without any benefit (almost identical volatility).
3- Our philosophy is clear:

Stay the course
This is perhaps the most challenging part of Boglehead investing, but is essential to its success. Bogleheads adopt a reasonable investment plan and then stay the course. [...]
Create an asset allocation that includes bonds to reduce the volatility caused by the stock part of your portfolio, then rebalance when needed. This balanced approach will help you to stay the course. Once you set up a Boglehead portfolio, the only real course correction needed is to rebalance once per year to bring the stock/bond allocations back to pre-set levels.
Best regards,

longinvest
What re-balancing strategy was used in this Portfolio Visualizer analysis?
The following two portfolios were compared:
  • 50/50 drifting to 37/63 stocks/bonds portfolio (no rebalancing)
  • 43.5/56.5 stocks/bonds portfolio rebalanced monthly
Is monthly re-balancing advisable or practical? I’m trying to write my IPS and figure out how/when to rebalance. I’m considering going with the 5/25 rule based on semi-annual check-ups, meaning: (1) I’d only check twice a year, (2) and I’d only act to re-balance if at those checkpoints the deviation from target was 5/25. Does this sound like an advisable approach?

Post Reply