Rebalancing Bonus

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Adam Mundorf
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Rebalancing Bonus

Post by Adam Mundorf »

Hey Everybody,

I'm sorry to bring up this topic since it's been discussed. I'm having hard time wrapping my head around it.

How does auto rebalancing not increase returns? Isn't it a way of buying low and selling high?

Thank you, Adam
FactualFran
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Re: Rebalancing Bonus

Post by FactualFran »

For rebalancing to increase return, the future return of the investment that money was moved to has to be greater than the future return of the investment that money was moved from. The future returns did not necessarily do that.
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Re: Rebalancing Bonus

Post by txhill »

Adam Mundorf wrote: Wed May 12, 2021 3:26 pm Hey Everybody,

I'm sorry to bring up this topic since it's been discussed. I'm having hard time wrapping my head around it.

How does auto rebalancing not increase returns? Isn't it a way of buying low and selling high?

Thank you, Adam
If everything returns to the mean, then rebalancing is good. But some investments are better than others, and if you keep shifting from the better to the worse, well...
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Adam Mundorf
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Re: Rebalancing Bonus

Post by Adam Mundorf »

txhill wrote: Wed May 12, 2021 3:45 pm
Adam Mundorf wrote: Wed May 12, 2021 3:26 pm Hey Everybody,

I'm sorry to bring up this topic since it's been discussed. I'm having hard time wrapping my head around it.

How does auto rebalancing not increase returns? Isn't it a way of buying low and selling high?

Thank you, Adam
If everything returns to the mean, then rebalancing is good. But some investments are better than others, and if you keep shifting from the better to the worse, well...
Ah I understand now, thank you! So essentially, rebalancing could be like catching a falling knife?
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Re: Rebalancing Bonus

Post by 123 »

Adam Mundorf wrote: Wed May 12, 2021 3:26 pm ...Isn't it a way of buying low and selling high?...
Situations could arise where all investment sectors (bonds AND stocks) are down. So the rebalancer could be selling positions at a loss to buy more of something that is down even more. There is no guarantee that markets will always rise. Of course some investors might be reluctant to sell in a loss situation because they are ever hopeful that it will "come back". Maybe it will eventually.
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Re: Rebalancing Bonus

Post by Triple digit golfer »

FactualFran wrote: Wed May 12, 2021 3:42 pm For rebalancing to increase return, the future return of the investment that money was moved to has to be greater than the future return of the investment that money was moved from. The future returns did not necessarily do that.
This says it all. Let's say you'r 80/20 and rebalance to 70/30 because stocks have had a run up. If stocks beat bonds in the next 10 years, your portfolio will be worse than had you not rebalanced. Of course, you also took on more risk, so it was not free.
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Re: Rebalancing Bonus

Post by Marseille07 »

Rebalancing bonus exists, but not in the way most posters here think (i.e. rebalancing stocks into bonds or vice versa).
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Re: Rebalancing Bonus

Post by Ferdinand2014 »

Adam Mundorf wrote: Wed May 12, 2021 3:26 pm Hey Everybody,

I'm sorry to bring up this topic since it's been discussed. I'm having hard time wrapping my head around it.

How does auto rebalancing not increase returns? Isn't it a way of buying low and selling high?

Thank you, Adam
Rebalancing bonus occasionally exists if done between asset classes that have similar expected returns (US/International stocks). It generally does not exist if done between asset classes with dissimilar expected returns (Stocks/bonds). It is also period dependent. What rebalancing does generally accomplish, is to reduce volatility for a given return. Some people use volatility as a proxy for risk.
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Adam Mundorf
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Re: Rebalancing Bonus

Post by Adam Mundorf »

Marseille07 wrote: Wed May 12, 2021 4:50 pm Rebalancing bonus exists, but not in the way most posters here think (i.e. rebalancing stocks into bonds or vice versa).
Yeah, I viewed like the other posters as well. Hm, the more you learn....
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Adam Mundorf
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Re: Rebalancing Bonus

Post by Adam Mundorf »

Ferdinand2014 wrote: Wed May 12, 2021 4:54 pm
Adam Mundorf wrote: Wed May 12, 2021 3:26 pm Hey Everybody,

I'm sorry to bring up this topic since it's been discussed. I'm having hard time wrapping my head around it.

How does auto rebalancing not increase returns? Isn't it a way of buying low and selling high?

Thank you, Adam
Rebalancing bonus occasionally exists if done between asset classes that have similar expected returns (US/International stocks). It generally does not exist if done between asset classes with dissimilar expected returns (Stocks/bonds). It is also period dependent. What rebalancing does generally accomplish, is to reduce volatility for a given return. Some people use volatility as a proxy for risk.
Okay, so the main benefit of rebalancing is a reduction of volatility. Thank you.
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Re: Rebalancing Bonus

Post by livesoft »

Do the math. Suppose "rebalancing does increase returns", so suppose one moves 10% of portfolio from bonds to equities at the right time and equities go up 5%. That would be 10% times 5% increase in performance over doing nothing assuming bonds do not change value. That's an extra 0.5% total performance. But one can also say that one cannot time it perfectly. Let's say one times it half perfectly, so that might be an extra 0.25% in total performance.

I'm afraid no one is going to be able to distinguish an extra 0.25% in extra performance since the performance dispersion of some 60/40 funds used as benchmarks is more than 10 times larger than that or more. One might have more small-cap value or less international in any given year and change their portfolio annual performance by more than 1% or 2%. People on this forum would call it luck and there is no way to get around that element of chance.
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Re: Rebalancing Bonus

Post by abuss368 »

Triple digit golfer wrote: Wed May 12, 2021 4:48 pm
FactualFran wrote: Wed May 12, 2021 3:42 pm For rebalancing to increase return, the future return of the investment that money was moved to has to be greater than the future return of the investment that money was moved from. The future returns did not necessarily do that.
This says it all. Let's say you'r 80/20 and rebalance to 70/30 because stocks have had a run up. If stocks beat bonds in the next 10 years, your portfolio will be worse than had you not rebalanced. Of course, you also took on more risk, so it was not free.
Jack Bogle has said rebalancing is something he never did. Not aware that he objected but never really recommended it.

Tony
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Re: Rebalancing Bonus

Post by Triple digit golfer »

abuss368 wrote: Wed May 12, 2021 7:43 pm
Triple digit golfer wrote: Wed May 12, 2021 4:48 pm
FactualFran wrote: Wed May 12, 2021 3:42 pm For rebalancing to increase return, the future return of the investment that money was moved to has to be greater than the future return of the investment that money was moved from. The future returns did not necessarily do that.
This says it all. Let's say you'r 80/20 and rebalance to 70/30 because stocks have had a run up. If stocks beat bonds in the next 10 years, your portfolio will be worse than had you not rebalanced. Of course, you also took on more risk, so it was not free.
Jack Bogle has said rebalancing is something he never did. Not aware that he objected but never really recommended it.

Tony
Fantastic.

If you don't rebalance, do you just always buy at a specific AA? That doesn't make a whole lot of sense. If you start at 60/40 and then it drifts up to 65/35, but you're buying at 60/40, what's the point? Seems scattered and silly and not really an AA at all.
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Re: Rebalancing Bonus

Post by grabiner »

Rebalancing improves the risk/return profile. If you hold asset A with an expected return of W and a standard deviation of X, and Asset with an expected return of Y and a standard deviation of Z and they are not perfectly correlated, a 50/50 portfolio of the two, rebalanced regularly, will have an expected return of more than (W+Y)/2 and a standard deviation of less than (X+Z)/2.

How the benefit shows up depends on the relative values of W and Y, and X and Z. For example, if A is a stock fund and B is a bond fund, the rebalanced portfolio will have lower expected returns than A, but you get more than half the excess returns of the stock market with about half the risk. If A is a US stock fund and B is a foreign stock fund with equal expected returns, the rebalanced portfolio will have slightly higher expected returns (but not that much higher since there are strong correlations).
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Re: Rebalancing Bonus

Post by Marseille07 »

Triple digit golfer wrote: Wed May 12, 2021 7:48 pm
abuss368 wrote: Wed May 12, 2021 7:43 pm
Triple digit golfer wrote: Wed May 12, 2021 4:48 pm
FactualFran wrote: Wed May 12, 2021 3:42 pm For rebalancing to increase return, the future return of the investment that money was moved to has to be greater than the future return of the investment that money was moved from. The future returns did not necessarily do that.
This says it all. Let's say you'r 80/20 and rebalance to 70/30 because stocks have had a run up. If stocks beat bonds in the next 10 years, your portfolio will be worse than had you not rebalanced. Of course, you also took on more risk, so it was not free.
Jack Bogle has said rebalancing is something he never did. Not aware that he objected but never really recommended it.

Tony
Fantastic.

If you don't rebalance, do you just always buy at a specific AA? That doesn't make a whole lot of sense. If you start at 60/40 and then it drifts up to 65/35, but you're buying at 60/40, what's the point? Seems scattered and silly and not really an AA at all.
Just buy bonds only in that case.
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Re: Rebalancing Bonus

Post by abuss368 »

Triple digit golfer wrote: Wed May 12, 2021 7:48 pm
Jack Bogle has said rebalancing is something he never did. Not aware that he objected but never really recommended it.

Tony
Fantastic.

If you don't rebalance, do you just always buy at a specific AA? That doesn't make a whole lot of sense. If you start at 60/40 and then it drifts up to 65/35, but you're buying at 60/40, what's the point? Seems scattered and silly and not really an AA at all.
[/quote]

Fantastic? Confused. So you think rebalancing is not necessary or you do rebalance?

Tony
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Re: Rebalancing Bonus

Post by Jaymover »

My understanding is that passive investing works best when you stay the course. The beauty of rebalancing is that it helps maintain discipline and stay the course.

You set your AA based on risk tolerance, time horizon etc. Say your 80/20 and it drifts to 85/15 after a year at which point it is usually suggested to rebalance back to 80/20. The trouble is that this will usually require selling stocks that have being going really well, which is hard, but is a forced way of being fearful when others are greedy.

The beauty of not rebalancing is that your stock allocation will generally drift upward which will probably result in better returns on average. Great if your rich like Mr Bogle!. However it is good to be aware that your time horizon might be shrinking and you will feel sad if things crash down just before you need to liquidate.

So deciding on an AA and regular rebalancing is a simple, cost effective investment strategy. Cost effective is good. Simple is good, and helpful when you are caught up in the fog of speculative voices and market noise.
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Re: Rebalancing Bonus

Post by willthrill81 »

grabiner wrote: Wed May 12, 2021 7:50 pm Rebalancing improves the risk/return profile. If you hold asset A with an expected return of W and a standard deviation of X, and Asset with an expected return of Y and a standard deviation of Z and they are not perfectly correlated, a 50/50 portfolio of the two, rebalanced regularly, will have an expected return of more than (W+Y)/2 and a standard deviation of less than (X+Z)/2.

How the benefit shows up depends on the relative values of W and Y, and X and Z. For example, if A is a stock fund and B is a bond fund, the rebalanced portfolio will have lower expected returns than A, but you get more than half the excess returns of the stock market with about half the risk. If A is a US stock fund and B is a foreign stock fund with equal expected returns, the rebalanced portfolio will have slightly higher expected returns (but not that much higher since there are strong correlations).
Correct. Below is an illustration using stocks and bonds.

From 1992 through last month, a 50/50 allocation to VFINX (S&P 500) and VFITX (intermediate-term Treasuries) without rebalancing had a CAGR of 8.54%, a standard deviation of 8.93%, a maximum drawdown of -27.99%, and a Sharpe ratio of .70. If annual rebalancing was done, the CAGR dropped to 8.28%, but the standard deviation dropped to 7.10%, the maximum drawdown dropped to -21.67%, and the Sharpe ratio increased to .83.

Of course, you cannot 'eat' a risk-adjusted return, so whether the historic reduction in volatility is justified by the expected loss of returns is up to each investor.
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Re: Rebalancing Bonus

Post by Marseille07 »

Jaymover wrote: Wed May 12, 2021 8:53 pm My understanding is that passive investing works best when you stay the course. The beauty of rebalancing is that it helps maintain discipline and stay the course.

You set your AA based on risk tolerance, time horizon etc. Say your 80/20 and it drifts to 85/15 after a year at which point it is usually suggested to rebalance back to 80/20. The trouble is that this will usually require selling stocks that have being going really well, which is hard, but is a forced way of being fearful when others are greedy.

The beauty of not rebalancing is that your stock allocation will generally drift upward which will probably result in better returns on average. Great if your rich like Mr Bogle!. However it is good to be aware that your time horizon might be shrinking and you will feel sad if things crash down just before you need to liquidate.

So deciding on an AA and regular rebalancing is a simple, cost effective investment strategy. Cost effective is good. Simple is good, and helpful when you are caught up in the fog of speculative voices and market noise.
But as you said, AA goes up *after* stocks have done well; and even if a subsequent crash might be a bit harder, you likely come out ahead not rebalancing than rebalancing.

This is why I'm a nudger rather than a rebalancer. I nudge new monies toward my AA, but I don't rebalance. Same for withdrawals.
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Re: Rebalancing Bonus

Post by Jaymover »

Hi Marseille

If your lucky enough to be saving (or getting distributions) and your AA is overweight in equities then you would put the new money into the defensive part first to get back toward your target AA. This is tax efficient. If no money is coming in for some reason, eg lost job, then you might have to sell some stocks during rebalancing to get back to the target.

My thoughts on dynamic asset allocation? Tempting to try and time the rebalancing date on each peak or dip but this is market timing so probably the good luck will be outweighed by getting it wrong half the time so why bother with the stress. Rebalance once a year.

So what is the rebalancing dividend the original poster was thinking about? It comes from the rebalancers having their steely wits about them because they are organised, unemotional and have a simple strategy.

Without a simple strategy to come back to you might do something emotional like remain conservative during a long bear market and miss out on recovery gains etc.
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Re: Rebalancing Bonus

Post by dogagility »

To quote Kitces' blog post title: "Portfolio Rebalancing Usually Reduces Long-Term Returns (But Is Good Risk Management Anyway)"

https://www.kitces.com/blog/how-rebalan ... nt-anyway/
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Re: Rebalancing Bonus

Post by Jaymover »

dogagility wrote: Thu May 13, 2021 3:37 am To quote Kitces' blog post title: "Portfolio Rebalancing Usually Reduces Long-Term Returns (But Is Good Risk Management Anyway)"

https://www.kitces.com/blog/how-rebalan ... nt-anyway/
The only trouble with this thesis is that often todays best performing sector is tomorrow's worst performing sector. I see this at the moment. One minute the call is growth, the next minute small caps, then next minute value. So much rotation. Just hold the whole lot and be less anxious. You more than likely supposed to do the opposite sell the good performing sectors regularly and buy the underperformers, which is what rebalancing is. Be unemotional about it.


It is a bit different if you are hanging on to one well performing company stock that you really believe in. Hang on to it then like Warren Buffet does.
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Re: Rebalancing Bonus

Post by dogagility »

Jaymover wrote: Thu May 13, 2021 3:50 am
dogagility wrote: Thu May 13, 2021 3:37 am To quote Kitces' blog post title: "Portfolio Rebalancing Usually Reduces Long-Term Returns (But Is Good Risk Management Anyway)"

https://www.kitces.com/blog/how-rebalan ... nt-anyway/
The only trouble with this thesis is that often todays best performing sector is tomorrow's worst performing sector. I see this at the moment. One minute the call is growth, the next minute small caps, then next minute value. So much rotation. Just hold the whole lot and be less anxious. You more than likely supposed to do the opposite sell the good performing sectors regularly and buy the underperformers, which is what rebalancing is. Be unemotional about it.

It is a bit different if you are hanging on to one well performing company stock that you really believe in. Hang on to it then like Warren Buffet does.
In the post, Kitces mentions that rebalancing between investments with similar expected returns may increase long-term returns. Apparently, Bernstein concluded this as well.

However, forum members typically discuss the "rebalancing bonus" when rebalancing between investments with differing expected returns (stocks vs bonds). Kitces outlines that there is no "bonus" to long term returns for a person in the accumulation phase in this scenario.
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Re: Rebalancing Bonus

Post by Jaymover »

In the post, Kitces mentions that rebalancing between investments with similar expected returns may increase long-term returns. Apparently, Bernstein concluded this as well.

However, forum members typically discuss the "rebalancing bonus" when rebalancing between investments with differing expected returns (stocks vs bonds). Kitces outlines that there is no "bonus" to long term returns for a person in the accumulation phase in this scenario.
First thing is look at the returns on that 50/50 portfolio before 1982! Never drops below 6.6 percent per annum. Hard to imagine these days.

Also it is a bit arse-up. Starting on a 50/50 portfolio with a 30 year horizon is not recommended these days, ie buy and hold and then retiring after 30 years with an 80/20. It should be the other round so that you rebalance down to a slightly lower stock allocation each year as you get older (glide path). I imagine that this might beat both scenarios and be more sensible from a risk management perspective.
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Re: Rebalancing Bonus

Post by firebirdparts »

It has to increase returns relative to something. What is that something? If you don't rebalance, in the current environment your stock portfolio will run away.

I think rebalancing makes you happy, but it can't increase returns relative to not rebalancing when the market is going up. The market goes up quite often. FWIW.
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Re: Rebalancing Bonus

Post by balbrec2 »

rebalancing should be thought of as a risk management tool.
Any difference in gains or losses vs. not rebalancing should be considered secondary.
These differences are usually very minor
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Re: Rebalancing Bonus

Post by willthrill81 »

Jaymover wrote: Thu May 13, 2021 5:05 am
In the post, Kitces mentions that rebalancing between investments with similar expected returns may increase long-term returns. Apparently, Bernstein concluded this as well.

However, forum members typically discuss the "rebalancing bonus" when rebalancing between investments with differing expected returns (stocks vs bonds). Kitces outlines that there is no "bonus" to long term returns for a person in the accumulation phase in this scenario.
First thing is look at the returns on that 50/50 portfolio before 1982! Never drops below 6.6 percent per annum. Hard to imagine these days.
As I showed above in this thread, there was no rebalancing bonus in terms of higher returns since 1992 for a 50/50, in which bonds did better than they 'should have' due to declining interest rates. But from 1941-1981, bonds lost -1.6% annually to inflation, so it's pretty easy to see that selling appreciated stocks to buy bonds that are losing value would have a negative impact on returns.

This doesn't mean that bonds should be eschewed, especially for retirees. But the idea that there has been a consistent rebalancing bonus, in terms of higher returns, between stocks and bonds just isn't supported by the data.
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Re: Rebalancing Bonus

Post by Marseille07 »

Jaymover wrote: Thu May 13, 2021 2:08 am So what is the rebalancing dividend the original poster was thinking about? It comes from the rebalancers having their steely wits about them because they are organised, unemotional and have a simple strategy.

Without a simple strategy to come back to you might do something emotional like remain conservative during a long bear market and miss out on recovery gains etc.
I think we're on the same page. What I don't agree with is the behavioral aspect.

Let's say my target AA is 60/40 and I'm a nudger. I'm adding new monies or withdrawing (doesn't matter which), in a nudging way toward 60/40. But my AA keeps drifting toward 70/30, let's say.

What just happened? I'm making more money, because stocks are necessarily appreciating (otherwise AA won't drift). People usually don't make behavioral mistakes while making money.

Now let's say a crash comes. Guess what? My AA would now move toward 60/40 automatically.
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Re: Rebalancing Bonus

Post by vineviz »

willthrill81 wrote: Thu May 13, 2021 9:57 am This doesn't mean that bonds should be eschewed, especially for retirees. But the idea that there has been a consistent rebalancing bonus, in terms of higher returns, between stocks and bonds just isn't supported by the data.
I agree.

Part of the confusion in these discussions, IMHO, come from a failure to define terms. If we're going to talk about a "rebalancing bonus", the return of the rebalanced portfolio has to be measured relative to something else. To me, the most logical comparison is a non-rebalanced portfolio with the same assets.

To make an example, I picked a period over which VFINX and VUSTX had nearly identical growth (June 1986 to August 2010). VFINX had a CAGR of 8.48% and VUSTX had a CAGR of 8.52% during this time. And a 50/50 portfolio that was NOT rebalanced had a CAGR of 8.5%, precisely the average of the two assets.

With annual rebalancing, though, the 50/50 portfolio earned a CAGR of 9.17%. The difference between the return of the rebalanced protofliio and the non-rebalanced portfolio can reasonably be called either a rebalancing bonus or a diversification bonus, because it results specifically from the act of rebalancing a diversified portfolio.
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Re: Rebalancing Bonus

Post by JackoC »

As discussed on a recent thread about leveraged ETF's, their theoretical return is:

LETF E[r]=L*mu-(L-1)r-0.5*L(L-1)*vol^2-ER
Where L is the leverage ratio, mu the equity index total return, r the financing rate, ER the fund expense ratio.

Which also applies when L is <1, and thus roughly quantifies the 'rebalancing bonus' under the usual lognormal distribution of returns diffusion process assumption about stock prices, which we know isn't exactly realistic but which we commonly speak in terms of (eg. when quoting options prices as implied volatility via the Black-Scholes equation).

With a little more sloppiness we can assume 'r' in this case is a bond return at L<1, though actually for a non-spot rate it would be a more complicated equation featuring correlation of bond and stock returns. Fortunately, though many with recency bias assume bond yields and stock prices are automatically positively correlated (bond and stock prices negative correlated), the long term average correlation is near zero, so I believe the simple equation is still OK for illustrative purposes.

Plugging in some numbers, ignoring ER for low cost index funds, at 60/40 L=.6, mu 6% nominal expected, r 1% nominal expected, vol 19% (~long term average of the VIX), then 60/40 E[r]=4.43%, whereas .6*.06+.4*.01=4.00%.

Of course we have to keep in mind that in real world investing there is no way to get 6*.06+.4*.01, that's just a back of the envelope estimate the equation says is systematically pessimistic for leverage <1. So it's a 'bonus' relative to something you can't actually do. Also if you 'never rebalance', assuming the estimates of stock and bond expected return are reasonable, you can expect to be more and more heavily stock over time. But you'll have a higher expected return than that by just being 100% (or more) stock in the first place. The reason you're rebalancing continuously to 60/40 isn't because you think a 'rebalancing bonus' is going to make the expected return beat that of an eventually much higher stock allocation*, but because you want/need to limit your exposure to the risk of stocks having a lower realized return than bonds.

*further playing with the equation you can see that that can be true if vol is very high. 60/40 slightly beats 100/0 at vol=41%. Again back to reality, short term realized vol is constantly changing, and the 'rebalancing' effect at low/high vols non-linear, so assuming a certain constant vol is a quite rough estimate.
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Re: Rebalancing Bonus

Post by Jaymover »

Let's say my target AA is 60/40 and I'm a nudger. I'm adding new monies or withdrawing (doesn't matter which), in a nudging way toward 60/40. But my AA keeps drifting toward 70/30, let's say.

What just happened? I'm making more money, because stocks are necessarily appreciating (otherwise AA won't drift). People usually don't make behavioral mistakes while making money.

Now let's say a crash comes. Guess what? My AA would now move toward 60/40 automatically.
I think this is a way of saying you never sell your growth assets but always top up into the defensive part when you are overweight in growth assets. The rule of "never ever sell my growth assets unless I need the money" is a good one. This way you can defer your capital gains tax events for a year when you might earn less. For instance you lose your job and during that low income year you can do a little bit of growth asset selling to rebalance (as long as there hasn't also just been a crash but often the two correlate).

I'm gonna add that rule to my investment strategy. Thanks
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Re: Rebalancing Bonus

Post by JamesDean44 »

vineviz wrote: Thu May 13, 2021 10:51 am
willthrill81 wrote: Thu May 13, 2021 9:57 am This doesn't mean that bonds should be eschewed, especially for retirees. But the idea that there has been a consistent rebalancing bonus, in terms of higher returns, between stocks and bonds just isn't supported by the data.
I agree.

Part of the confusion in these discussions, IMHO, come from a failure to define terms. If we're going to talk about a "rebalancing bonus", the return of the rebalanced portfolio has to be measured relative to something else. To me, the most logical comparison is a non-rebalanced portfolio with the same assets.

To make an example, I picked a period over which VFINX and VUSTX had nearly identical growth (June 1986 to August 2010). VFINX had a CAGR of 8.48% and VUSTX had a CAGR of 8.52% during this time. And a 50/50 portfolio that was NOT rebalanced had a CAGR of 8.5%, precisely the average of the two assets.

With annual rebalancing, though, the 50/50 portfolio earned a CAGR of 9.17%. The difference between the return of the rebalanced protofliio and the non-rebalanced portfolio can reasonably be called either a rebalancing bonus or a diversification bonus, because it results specifically from the act of rebalancing a diversified portfolio.
I may just be being dense, but would you mind elaborating on what you mean by a "failure to define terms?" I have never grasped the view that there isn't a rebalancing bonus or a diversification bonus, and I'm trying to understand what that means. Do those folks just mean you are unlikely to improve absolute returns by selling an asset with high expected returns (e.g. equities) and buying an asset with lower expected returns (e.g. bonds)?

Shannon's Demon provides a nice hypothetical example. Or to see an actual example, just running a few backtests with and without rebalancing using a portfolio with somewhat uncorrelated assets such as US equities, EM equities, long term treasuries, and gold.
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vineviz
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Re: Rebalancing Bonus

Post by vineviz »

JamesDean44 wrote: Fri May 14, 2021 10:21 pm I have never grasped the view that there isn't a rebalancing bonus or a diversification bonus, and I'm trying to understand what that means. Do those folks just mean you are unlikely to improve absolute returns by selling an asset with high expected returns (e.g. equities) and buying an asset with lower expected returns (e.g. bonds)?
I think that's what those folks usually mean.
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Ferdinand2014
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Re: Rebalancing Bonus

Post by Ferdinand2014 »

Adam Mundorf wrote: Wed May 12, 2021 5:04 pm
Ferdinand2014 wrote: Wed May 12, 2021 4:54 pm
Adam Mundorf wrote: Wed May 12, 2021 3:26 pm Hey Everybody,

I'm sorry to bring up this topic since it's been discussed. I'm having hard time wrapping my head around it.

How does auto rebalancing not increase returns? Isn't it a way of buying low and selling high?

Thank you, Adam
Rebalancing bonus occasionally exists if done between asset classes that have similar expected returns (US/International stocks). It generally does not exist if done between asset classes with dissimilar expected returns (Stocks/bonds). It is also period dependent. What rebalancing does generally accomplish, is to reduce volatility for a given return. Some people use volatility as a proxy for risk.
Okay, so the main benefit of rebalancing is a reduction of volatility. Thank you.
Yes.
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tetractys
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Re: Rebalancing Bonus

Post by tetractys »

Rebalancing bonus works well with bands in volatile markets, which we’ve had a lot of. It does not work with annual rebalancing, which bizarrely those who argue against it seem to rely on.
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