rebalancing conundrum/paradox/irony

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letsgobobby
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rebalancing conundrum/paradox/irony

Post by letsgobobby » Sat Sep 27, 2014 12:05 am

long story short:

For years I've been 60/40, with 90%+ of all new contributions going to fixed income. This has worked because the stock market is going up 25% per year for the last five years, so my portfolio stays balanced. Really haven't had to rebalance at all during that period of time.

But in 2014 the stock market is up much less - small caps are down, total market up single digits. As a result, stock gains aren't sufficient to keep portfolio in balance so I'm becoming overweighted in fixed income.

If this continues I'll have to use new contributions to buy stocks, if I want to follow my IPS and maintain my portfolio's risk profile. The paradox is my risk-managing IPS is now requiring me to buy more risky assets for the first time in 5+ years, after those risky assets have doubled or tripled in value while the less risky assets have gone up 20-30%.

This seems very counterintuitive to me...

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Re: rebalancing conundrum/paradox/irony

Post by rkhusky » Sat Sep 27, 2014 12:20 am

Really? You expect stocks to always do better than bonds, just because they are riskier? When stocks are rising you have to buy more bonds. When stocks are dropping you have to buy more stocks. That is, if you want to maintain a fixed stock/bond ratio. There are those that advocate never buying stocks when they are dropping, but then they don't have a fixed stock/bond ratio.

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Re: rebalancing conundrum/paradox/irony

Post by John3754 » Sat Sep 27, 2014 12:21 am

How about international stocks? They've been considerably lagging behind domestic stocks for the past few years.

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Re: rebalancing conundrum/paradox/irony

Post by letsgobobby » Sat Sep 27, 2014 12:28 am

rkhusky wrote: When stocks are dropping you have to buy more stocks.
Agree, but that's not what's happening here. Stocks continue to rise to all time record highs, but not fast enough to offset fixed income contributions/gains.

Is my risk determined by the percentage of portfolio invested in risky assets, or by dollar amount invested in risky assets?

In other words, if I knew I was always going to have to buy more stocks in the future barring 25%+ returns forever, why didn't I just do it five years ago, four years ago, etc? I had the money and instead invested it in bonds.

Likewise it appears I will have to continue to buy more stocks in the future, as well. For example if I have $600k in stocks and $400k in bonds now and I predict when I retire I will have $1200k in stocks and $800k in bonds, shouldn't all $1000k that I have now be in stocks? I should buy now, at a presumably lower price, all the risky assets I will ever plan to own/buy in the future, if I have the money. Then I should sell those (presumably) appreciated assets once I hit the $1200k target, and build low risk assets in that manner and at that time.

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Re: rebalancing conundrum/paradox/irony

Post by 555 » Sat Sep 27, 2014 3:18 am

Aha! So now you see the wisdom of a glidepath!

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Re: rebalancing conundrum/paradox/irony

Post by Tigermoose » Sat Sep 27, 2014 6:30 am

555 wrote:Aha! So now you see the wisdom of a glidepath!
Yep. Setting up a glide path helps you to take more equity risk earlier in your investing lifetime and slowly taper it down as you get closer to retirement. That said, you might want to wait for a 5-10% correction in the stock market before readjusting your portfolio. I know, I'm a bad market timer for saying that, but...just sayin'.
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Re: rebalancing conundrum/paradox/irony

Post by JoMoney » Sat Sep 27, 2014 7:12 am

Tigermoose wrote:
555 wrote:Aha! So now you see the wisdom of a glidepath!
Yep. Setting up a glide path helps you to take more equity risk earlier in your investing lifetime and slowly taper it down as you get closer to retirement. That said, you might want to wait for a 5-10% correction in the stock market before readjusting your portfolio. I know, I'm a bad market timer for saying that, but...just sayin'.
... right, things changing 5-10% might happen at some point, if the economy starts improving stocks could easily grow, it might push the Fed into rising interest rates causing bonds to fall, and you might find yourself in the reversed situation you seem to want to be in :D
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Re: rebalancing conundrum/paradox/irony

Post by larryswedroe » Sat Sep 27, 2014 7:41 am

let'sgobobby
Here's something you MIGHT have missed
an IPS should be a LIVING document, being adjusted as life events occur and even bull or bear markets impact your ability, willingness or need to take risk

In other words if the bull market has now put you ahead of your plan than you should revisit your IPS ---and adjust it -- bull markets can be just like inheritances lowering your need to take risk ---if you are in later stages of your investment life cycle and have already accumulated significant assets.

Larry

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Re: rebalancing conundrum/paradox/irony

Post by Leesbro63 » Sat Sep 27, 2014 7:59 am

Larry makes a good point. You might be well ahead of where you expected to be. And might consider lowering your equity allocation. That being said, if you are young (and your ability to save so much fixed income versus the entirety of your portfolio suggests you are in the earlier stages of your investment life), you might be doing yourself a disservice by changing your allocation now. This could morph into market timing. "The DOW tripled in 5 years so I won't add to my equity portion until it falls". And you never quite get back to adding to equities. Maybe the market never falls substantially from here....maybe it goes to 22,000 before falling to 19,000. Or maybe it stays at 17,000. Or maybe it goes gradually to 18,000 but inflation heats up so it's a decline in real terms. My point is that you don't know how this will play out and if your equity allocation is the right number, you are taking risk by NOT following it, just as you are taking risk in sticking to it (adding equities after a DOW triple).

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Re: rebalancing conundrum/paradox/irony

Post by Dandy » Sat Sep 27, 2014 8:05 am

That is what happens when a well thought out IPS meets the reality down the road. If the IPS wasn't well thought out you need a new IPS. Buying stocks when the market is at or near historic highs is counter intuitive. It is logical to trim stocks when they are "high" but is it letting your emotions get carried away? Are you trying to time the market?

It essentially gets to the question of when do you vary from your plan? Some say never. I say it depends. In retirement, if you are in good shape, varying from the plan to take a bit less risk? Maybe. In the accumulation stage? Maybe not. Reaction to media hype? Never Reaction to objective data? Maybe

If my IPS said buy 10 year Treasuries and down the road a 10 year CD is paying 80 basis points higher (something I didn't anticipate in my IPS) do I "violate" my IPS and go for a 10 yr CD? Why not? It isn't in reaction to panic/media hype - there is some objective data to help you decide -- and it is essentially the same risk.

The equity market is at or near its historic high after several years of gains. If you are in retirement it is logical to be concerned with increasing equity purchases. You are in charge not your IPS. If you decide to vary from the plan try to make sure it isn't due to panic, that it isn't increasing your risk and is based on factual data not emotions/fear. And - do it very infrequently.

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Re: rebalancing conundrum/paradox/irony

Post by rkhusky » Sat Sep 27, 2014 8:09 am

letsgobobby wrote: I should buy now, at a presumably lower price, all the risky assets I will ever plan to own/buy in the future, if I have the money. Then I should sell those (presumably) appreciated assets once I hit the $1200k target, and build low risk assets in that manner and at that time.
Because you don't know it is a lower price.

Based on past performance, we expect stocks to continue to rise, but it will only do so over a given time period with a given probability. As others have said, if you have a long investing time horizon and based on past performance, the probability is fairly low that stocks will under-perform bonds in the time period that you have left until retirement. If you are close to retirement, the odds increase that stocks will under-perform bonds in the time period that you have left until retirement.

It all depends on your ability and willingness to take risk.

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Re: rebalancing conundrum/paradox/irony

Post by Leesbro63 » Sat Sep 27, 2014 8:16 am

Dandy wrote: If my IPS said buy 10 year Treasuries and down the road a 10 year CD is paying 80 basis points higher (something I didn't anticipate in my IPS) do I "violate" my IPS and go for a 10 yr CD? Why not? It isn't in reaction to panic/media hype - there is some objective data to help you decide -- and it is essentially the same risk.
I would argue that this is a bad analogy. It's understood that CDs and Treasuries are essentially the same thing with similar risk profiles. Yeah, CDs have early withdrawal features and Treasuries are not taxed at the state level. But essentially it's a no-brainer that you buy the fixed income security with the best coupon at the moment for a given maturity date. This is NOT the same thing at all as having an IPS that says "I'll be 60% equity" then deciding that since equities have run up, you won't keep adding to maintain that percentage.

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Re: rebalancing conundrum/paradox/irony

Post by YDNAL » Sat Sep 27, 2014 8:40 am

letsgobobby wrote:long story short:

For years I've been 60/40, with 90%+ of all new contributions going to fixed income. This has worked because the stock market is going up 25% per year for the last five years, so my portfolio stays balanced. Really haven't had to rebalance at all during that period of time.
I have 3 questions (rhetorical, mostly) to ponder.
  • 1. Why do you care about percentages?

    2. Your IPS should be driven by ability & need for risk (willingness is psychological). All else equal, the risk in your portfolio is not the same with 100 shares x $1 versus 100 shares x $2. If you take risk of $100 with the former (say 5 years ago), why are you taking risk of $200 with the latter (say today)?

    3. If your fixed income has increased to a certain level, how does that level compare to your ultimate goal?
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Re: rebalancing conundrum/paradox/irony

Post by ks289 » Sat Sep 27, 2014 9:40 am

I think the standard of not buying stocks (auto rebalancing through gains) is less and less likely to be sufficient also as your portfolio grows and new contributions are dwarfed by the overall portfolio. At some point, you likely would have to contribute new money in roughly the proportions of the desired allocation.

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Re: rebalancing conundrum/paradox/irony

Post by livesoft » Sat Sep 27, 2014 9:58 am

In a situation like this, where IPS / rebalancing says to buy equities and one thinks equities smell, I still buy equities, but only in a taxable account. If equities then fall, I do the TLH thing and shove some of the loss onto the IRS.
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Re: rebalancing conundrum/paradox/irony

Post by cfs » Sat Sep 27, 2014 10:04 am

Good conversation.

Good conversation, very good info, the re-balancing act is one of the reasons on moving to balanced funds, let the managers do the jury-rigging.
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Re: rebalancing conundrum/paradox/irony

Post by Leesbro63 » Sat Sep 27, 2014 10:30 am

livesoft wrote:In a situation like this, where IPS / rebalancing says to buy equities and one thinks equities smell, I still buy equities, but only in a taxable account. If equities then fall, I do the TLH thing and shove some of the loss onto the IRS.
I am on the opposite side of this. Did TLH in 2009 and now can't rebalance because the tax cost is very high.

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Re: rebalancing conundrum/paradox/irony

Post by Dandy » Sat Sep 27, 2014 11:02 am

I would argue that this is a bad analogy.

Reasonable point - all analogies are imperfect. If you didn't anticipate in your IPS having to buy equities when they are high - you may have to re think your IPS. Do some soul searching before you revise your IPS - you don't want to change it too frequently. Maybe it has been awhile since you framed your IPS and now your situation or risk tolerance has changed. It is hard to sort out emotions in investing that is why generally it is better to go with a well thought out plan made when emotions were not high. It is easy to rationalize any investment decision - that's the problem.

I usually follow my plan but am not a slave to it. But when I vary from it I try to base it on some objective rather than subjective reasons. e.g. I had more of a commitment to short and intermediate term bond funds but decided that some allocation to mid term CDs offered better risk/return. Very little emotion involved. I'm not scared of rising interest rates I'm locking in some better yields that fit my needs and the purpose of my fixed income allocation which is stability and low risk. I am being flexible and maybe opportunistic rather than strictly dogmatic. An IPS written 10 years ago would not even considered CDs.

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Re: rebalancing conundrum/paradox/irony

Post by letsgobobby » Sat Sep 27, 2014 2:07 pm

For those who could tolerate this may be a reason to be almost entirely stocks until the long term projected terminal value of stock holdings based on some reasonable guesstimate of returns are sufficient to match terminal desired stock holdings. After that everything goes to fixed income.
Last edited by letsgobobby on Sat Sep 27, 2014 2:15 pm, edited 1 time in total.

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Re: rebalancing conundrum/paradox/irony

Post by livesoft » Sat Sep 27, 2014 2:13 pm

Leesbro63 wrote:
livesoft wrote:In a situation like this, where IPS / rebalancing says to buy equities and one thinks equities smell, I still buy equities, but only in a taxable account. If equities then fall, I do the TLH thing and shove some of the loss onto the IRS.
I am on the opposite side of this. Did TLH in 2009 and now can't rebalance because the tax cost is very high.
What? I thought you stated that you need to buy more equities. If that is the case, one would not sell any equities in taxable. If you need to sell fixed income and buy equities, presumably you have some fixed income in tax-advantaged that you can exchange into equities. Thus you should be able to rebalance without any tax cost.
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Re: rebalancing conundrum/paradox/irony

Post by Buddtholomew » Sat Sep 27, 2014 2:27 pm

I am in a similar position as the OP. Tax-deferred contributions have been allocated between fixed income and stable value funds for years to maintain AA. International and emerging market investments are moderately underweight and I plan to re-balance when a tolerance bands is breached. I can always think of a reason to abandon the plan - e.g. a strengthening USD and the currency impact on INT investments - the key is to follow the plan even after you have convinced yourself that you are doing the wrong thing...
"The first principle is that you must not fool yourself and you are the easiest person to fool" --Feynman.

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Re: rebalancing conundrum/paradox/irony

Post by nedsaid » Sat Sep 27, 2014 2:44 pm

I feel like the model in the famous painting "Silent Scream." Oh no, not another thread on rebalancing. Perhaps reading the various threads on rebalancing would be enough torture to make the most hardened terrorist confess to everything.

I went from defending my rather relaxed attitude towards rebalancing to starting to feel guilty about not rebalancing. I was getting pretty bruised and battered from getting beaten with foam rubber hammers by my fellow Bogleheads. With a very strong 2013 stock market performance, coupled with the great Boglehead Bond Crash of 2013, I decided it was time to execute a program of mild rebalancing from stocks to bonds. Sell stocks when they are strong and buy bonds when they are down. I had the additional benefit of feeling that I had done something wholesome and moral by rebalancing my investments. This forum acted as sort of a confession booth where I could confess my investing sins. I had one less investing sin now that I had rebalanced and renounced my formerly lackadaisical ways.

Then once I started feeling really good about myself, someone else starts a thread on "dangerous rebalancing." I feel like the poor guy who read studies that said coffee was bad for you. So he gave up coffee and felt good about his decision until he later read newer studies that said coffee was good for you. I learned that I may have done something downright dangerous to my future financial state. I felt like a chump. Then I read further and saw that rebalancing was dangerous when you rebalanced from bonds to stocks in a down stock market because no one knows what the floor is. I felt greatly relieved. Maybe I did the right thing after all.

So LetsGoBobby, I can feel a bit of your pain. I am having a bit of fun with this, but I thought one poster had a very sensible suggestion. As you have to start buying stocks again, you might want to consider International Stocks and even Emerging Markets Stocks as both are cheaper than US Stocks. Plus the US Dollar is strong now and that means you can buy even more foreign shares with your dollar than you could before. That is what I would do, keep your US Stock investments intact but direct new investment monies to International Stocks. If you feel a bit frisky, overweight your International purchases with Emerging Markets.
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Re: rebalancing conundrum/paradox/irony

Post by telemark » Sat Sep 27, 2014 2:45 pm

Most of the stock you own now has a very low basis. You are now going to buy a small amount with a much higher basis. This is unlikely to matter much. I think you're overthinking this.

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Re: rebalancing conundrum/paradox/irony

Post by letsgobobby » Sat Sep 27, 2014 3:00 pm

telemark wrote:Most of the stock you own now has a very low basis. You are now going to buy a small amount with a much higher basis. This is unlikely to matter much. I think you're overthinking this.
But "we've only just begun..." if I accumulate for twenty more years this will happen repeatedly.

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Re: rebalancing conundrum/paradox/irony

Post by letsgobobby » Sat Sep 27, 2014 3:10 pm

This is really a cousin of the lump sum vs dca argument. Lump summing is better on average. If I have the money I should invest it all now. Dca is only better on average when you can't lump sum.

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Re: rebalancing conundrum/paradox/irony

Post by retiredjg » Sat Sep 27, 2014 3:26 pm

letsgobobby wrote:
telemark wrote:Most of the stock you own now has a very low basis. You are now going to buy a small amount with a much higher basis. This is unlikely to matter much. I think you're overthinking this.
But "we've only just begun..." if I accumulate for twenty more years this will happen repeatedly.
Yes, it will happen repeatedly. That is because it is supposed to happen this way. If the stocks grow a little slower or bonds grow a little faster or if you increase your contributions, or any combination of these things, this may happen. It is no big deal.

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Re: rebalancing conundrum/paradox/irony

Post by retiredjg » Sat Sep 27, 2014 3:27 pm

letsgobobby wrote:For those who could tolerate this may be a reason to be almost entirely stocks until the long term projected terminal value of stock holdings based on some reasonable guesstimate of returns are sufficient to match terminal desired stock holdings. After that everything goes to fixed income.
bobby, you've lost your mind. What is going on with you?

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Re: rebalancing conundrum/paradox/irony

Post by Leesbro63 » Sat Sep 27, 2014 3:43 pm

livesoft wrote:
Leesbro63 wrote:
livesoft wrote:In a situation like this, where IPS / rebalancing says to buy equities and one thinks equities smell, I still buy equities, but only in a taxable account. If equities then fall, I do the TLH thing and shove some of the loss onto the IRS.
I am on the opposite side of this. Did TLH in 2009 and now can't rebalance because the tax cost is very high.
What? I thought you stated that you need to buy more equities. If that is the case, one would not sell any equities in taxable. If you need to sell fixed income and buy equities, presumably you have some fixed income in tax-advantaged that you can exchange into equities. Thus you should be able to rebalance without any tax cost.
Sorry. I guess this got confused. I am NOT the original poster who needed to add equities. I'm just another voice in the wilderness!

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Re: rebalancing conundrum/paradox/irony

Post by livesoft » Sat Sep 27, 2014 3:58 pm

Leesbro63 wrote:I am NOT the original poster who needed to add equities. I'm just another voice in the wilderness!
My bad. Sorry.

I rebalanced out of equities back in June 2014 in my 401(k). I have tracked what would have happened if I had done nothing. Well, the first thing that happened was that equities went up, so I would have been better off not rebalancing or delaying rebalancing. But this weekend, I am now 0.5% better off for rebalancing. I will not predict what happens next week.
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Re: rebalancing conundrum/paradox/irony

Post by letsgobobby » Sat Sep 27, 2014 4:33 pm

Jan, I don't think I've lost my mind but you be the judge.

Imagine someone's goal is to retire with $1M real in 10 years, and he has $400k now split 60/40 ($240k in stocks, $160k in bonds) and he plans to stay 60/40 til retirement. That implies he'll retire with $600k in stocks and $400k in bonds. He needs 5% real return to reach his goals and guesses that stocks will return 7% real and bonds 2% real to get that.

He saves $15k per year.

His current stock holdings of $240k are predicted to grow to $240*(1.07)^10 = $472k in 10 years. His retirement goal is closer to $600k, so he needs more stocks.

Why wouldn't he invest all $15k in stocks this year? Why would he invest 60/40 in stocks/bonds; why put anything in bonds? He knows that he'll have to continue to buy stocks for many years if he only puts 60% of $15k in stocks each year.

Back to the LS vs DCA argument. Isn't he basically being advised to DCA when he has a lump sum available? Why would he follow that advice when that is not the usual advice given with respect to optimizing returns?

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Re: rebalancing conundrum/paradox/irony

Post by retiredjg » Sat Sep 27, 2014 5:20 pm

letsgobobby wrote:Why wouldn't he invest all $15k in stocks this year? Why would he invest 60/40 in stocks/bonds; why put anything in bonds? He knows that he'll have to continue to buy stocks for many years if he only puts 60% of $15k in stocks each year.
Two reasons.
  • 1) You can't assume the market is always going to go up - stocks may NOT be cheaper now than later. You might get to buy a whole passel of stocks at rock bottom prices during the crashes that will happen between now and then. That is why you pick something you can live with and live with it - because you don't know what is going to happen.

    2) Your asset allocation is supposed to reflect your need, ability, and willingness to take risk. You picked 60/40 awhile back based on something. Perhaps, you didn't want to take a lot of risk because you thought it would be uncomfortable (willingness). Perhaps you also realized that you did not need to take a lot of risk because you were able to save a lot of money (need). As for ability to take risk, I think you do have the ability to take it (you have long enough before retirement for a recovery).
Now that you've been investing for awhile, you may have unconsciously decided or even consciously realized that you are more willing to take more risk. If that is true, you might revisit your IPS and change it. But that will mean buying even more stocks at "these high prices" so I don't think that is a real solution to your conundrum. :D

Do you see that you started this thread thinking it was counterintuitive to buy more stocks and now you are considering buying even more stocks?

Work your plan, letsgobobby. As I recall, you have a pretty good one. If you haven't already done it, add a paragraph in your plan that prohibits changes without 6 months consideration. Or a year's consideration might be even better. Then work your plan.

BTW, I feel sure you understood the tone of my "bobby you have lost your mind!". Thanks for not taking offense cause it was certainly not meant to be offensive. I sometimes feel like your elderly aunt and knew you would know it was said with much caring. :happy

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Re: rebalancing conundrum/paradox/irony

Post by technovelist » Sat Sep 27, 2014 5:37 pm

Does this count as a toppy indicator, such as "Why isn't everyone 100% 200% stocks?"?
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Re: rebalancing conundrum/paradox/irony

Post by letsgobobby » Sat Sep 27, 2014 5:59 pm

technovelist wrote:Does this count as a toppy indicator, such as "Why isn't everyone 100% 200% stocks?"?
The opposite, I'd say the argument would be even more compelling if stocks were cheap.

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Re: rebalancing conundrum/paradox/irony

Post by Buddtholomew » Sat Sep 27, 2014 9:42 pm

nedsaid wrote:I feel like the model in the famous painting "Silent Scream." Oh no, not another thread on rebalancing. Perhaps reading the various threads on rebalancing would be enough torture to make the most hardened terrorist confess to everything.

I went from defending my rather relaxed attitude towards rebalancing to starting to feel guilty about not rebalancing. I was getting pretty bruised and battered from getting beaten with foam rubber hammers by my fellow Bogleheads. With a very strong 2013 stock market performance, coupled with the great Boglehead Bond Crash of 2013, I decided it was time to execute a program of mild rebalancing from stocks to bonds. Sell stocks when they are strong and buy bonds when they are down. I had the additional benefit of feeling that I had done something wholesome and moral by rebalancing my investments. This forum acted as sort of a confession booth where I could confess my investing sins. I had one less investing sin now that I had rebalanced and renounced my formerly lackadaisical ways.

Then once I started feeling really good about myself, someone else starts a thread on "dangerous rebalancing." I feel like the poor guy who read studies that said coffee was bad for you. So he gave up coffee and felt good about his decision until he later read newer studies that said coffee was good for you. I learned that I may have done something downright dangerous to my future financial state. I felt like a chump. Then I read further and saw that rebalancing was dangerous when you rebalanced from bonds to stocks in a down stock market because no one knows what the floor is. I felt greatly relieved. Maybe I did the right thing after all.

So LetsGoBobby, I can feel a bit of your pain. I am having a bit of fun with this, but I thought one poster had a very sensible suggestion. As you have to start buying stocks again, you might want to consider International Stocks and even Emerging Markets Stocks as both are cheaper than US Stocks. Plus the US Dollar is strong now and that means you can buy even more foreign shares with your dollar than you could before. That is what I would do, keep your US Stock investments intact but direct new investment monies to International Stocks. If you feel a bit frisky, overweight your International purchases with Emerging Markets.
I'm interested in the argument to purchase International and Emerging Markets equities with the head winds of a strengthening dollar. I'm concerned that currency fluctuations will outweigh any potential gains we see in the European markets.

OP, are you in a similar situation or is your question specific to US markets only. It's hard to imagine that US has fallen enough to warrant a rebalance into domestic equities. Fixed income has outperformed international investments, commodities and gold.
"The first principle is that you must not fool yourself and you are the easiest person to fool" --Feynman.

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Re: rebalancing conundrum/paradox/irony

Post by inbox788 » Sun Sep 28, 2014 12:20 am

letsgobobby wrote:
rkhusky wrote: When stocks are dropping you have to buy more stocks.
Agree, but that's not what's happening here. Stocks continue to rise to all time record highs, but not fast enough to offset fixed income contributions/gains.

Is my risk determined by the percentage of portfolio invested in risky assets, or by dollar amount invested in risky assets?

In other words, if I knew I was always going to have to buy more stocks in the future barring 25%+ returns forever, why didn't I just do it five years ago, four years ago, etc? I had the money and instead invested it in bonds.

Likewise it appears I will have to continue to buy more stocks in the future, as well. For example if I have $600k in stocks and $400k in bonds now and I predict when I retire I will have $1200k in stocks and $800k in bonds, shouldn't all $1000k that I have now be in stocks? I should buy now, at a presumably lower price, all the risky assets I will ever plan to own/buy in the future, if I have the money. Then I should sell those (presumably) appreciated assets once I hit the $1200k target, and build low risk assets in that manner and at that time.
In general AA is determined by the percentage. You're mixing your AA and investment strategy/rebalancing strategy. And you've got your cart before your horse if you're looking at future projections. Begin with your AA today and align it with your desired AA of 60/40. If the market drops, so your AA is now 55/45, you rebalance by selling bonds and buying stocks. If the market rises (as it seems it has for your) AA goes to 65/35, you sell stocks and buy bonds.

So what do you do with new money? Easy, invest it in a 60/40 AA. What you've been doing is instead of selling stocks and buying bonds to rebalance AND buying 60/40 bonds AND stocks, you've pretty much cancelled out the selling and buying of stocks and just added bonds to keep AA even. In a year when stocks and bonds gain evenly or bonds outperform stocks, you still rebalance AND invest new money in a 60/40 AA. This may mean the net effect is to buy stocks.

http://www.bogleheads.org/wiki/Asset_allocation

http://www.bogleheads.org/wiki/Rebalancing
Rebalancing is the action of bringing a portfolio that has deviated away from one's target asset allocation back into line. The objective is to maintain a consistent mix of asset classes (most commonly equities vs. fixed income) in order to control risk at the level desired by the investor. This is accomplished by transferring funds from higher-performing classes to lower-performing classes. While potentially counterintuitive, rebalancing ensures that investors "Buy Low" and "Sell High".

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Re: rebalancing conundrum/paradox/irony

Post by Rodc » Sun Sep 28, 2014 2:48 am

You can't always buy low. You'd love to but without a crystal ball you won't. The point of Bogleheadism is to make peace with this. You win some, you lose some, over time you'll be about average (but, at very low cost so you will likely come out a little bit ahead). Just like holding a diversified portfolio: you hold the winners and the losers, but on average you are fine.

If you had a crystal ball you would have gone 100% stocks five years ago, but you didn't. If you had a crystal ball today you'd know to go 100% stocks, or to go 100% bonds and you'd know when to switch back and forth, but you don't.

Remember too, historically even buying high has worked out fine for the buy and hold stock investor.

As someone else said, just keep working your plan, revisit plan maybe every five years to see if needs, ability etc have changed and rework your plan if warranted.
Last edited by Rodc on Sun Sep 28, 2014 6:33 am, edited 1 time in total.
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Re: rebalancing conundrum/paradox/irony

Post by richard » Sun Sep 28, 2014 6:24 am

letsgobobby wrote:<snip>If this continues I'll have to use new contributions to buy stocks, if I want to follow my IPS and maintain my portfolio's risk profile. The paradox is my risk-managing IPS is now requiring me to buy more risky assets for the first time in 5+ years, after those risky assets have doubled or tripled in value while the less risky assets have gone up 20-30%.

This seems very counterintuitive to me...
You should be comparing stocks and bonds to each other today, not stocks today to stocks five years ago.

Also, a constant asset allocation does not necessarily maintain a constant level of risk. The relative risk and stocks and bonds can change and the absolute level of risk of both can change.

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Re: rebalancing conundrum/paradox/irony

Post by richard » Sun Sep 28, 2014 6:29 am

retiredjg wrote:<snip>Work your plan, letsgobobby. As I recall, you have a pretty good one. If you haven't already done it, add a paragraph in your plan that prohibits changes without 6 months consideration. Or a year's consideration might be even better. Then work your plan.<>
Everyone's IPS should contain this provision, although there might be an exception for changes due to changes in wealth.

I'd suggest longer periods if you're changing to increase something that has gone up recently or to decrease something that has dropped.

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Re: rebalancing conundrum/paradox/irony

Post by retiredjg » Sun Sep 28, 2014 6:59 am

Rodc wrote:You can't always buy low. You'd love to but without a crystal ball you won't. The point of Bogleheadism is to make peace with this.
I like this!

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Re: rebalancing conundrum/paradox/irony

Post by livesoft » Sun Sep 28, 2014 7:13 am

One also has to make peace with losing money. Once you know you are going to lose money and accept that fact, then as an investor you are liberated and have reached freedom.
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Re: rebalancing conundrum/paradox/irony

Post by nedsaid » Sun Sep 28, 2014 7:15 am

Buddtholomew wrote:
nedsaid wrote:I feel like the model in the famous painting "Silent Scream." Oh no, not another thread on rebalancing. Perhaps reading the various threads on rebalancing would be enough torture to make the most hardened terrorist confess to everything.

I went from defending my rather relaxed attitude towards rebalancing to starting to feel guilty about not rebalancing. I was getting pretty bruised and battered from getting beaten with foam rubber hammers by my fellow Bogleheads. With a very strong 2013 stock market performance, coupled with the great Boglehead Bond Crash of 2013, I decided it was time to execute a program of mild rebalancing from stocks to bonds. Sell stocks when they are strong and buy bonds when they are down. I had the additional benefit of feeling that I had done something wholesome and moral by rebalancing my investments. This forum acted as sort of a confession booth where I could confess my investing sins. I had one less investing sin now that I had rebalanced and renounced my formerly lackadaisical ways.

Then once I started feeling really good about myself, someone else starts a thread on "dangerous rebalancing." I feel like the poor guy who read studies that said coffee was bad for you. So he gave up coffee and felt good about his decision until he later read newer studies that said coffee was good for you. I learned that I may have done something downright dangerous to my future financial state. I felt like a chump. Then I read further and saw that rebalancing was dangerous when you rebalanced from bonds to stocks in a down stock market because no one knows what the floor is. I felt greatly relieved. Maybe I did the right thing after all.

So LetsGoBobby, I can feel a bit of your pain. I am having a bit of fun with this, but I thought one poster had a very sensible suggestion. As you have to start buying stocks again, you might want to consider International Stocks and even Emerging Markets Stocks as both are cheaper than US Stocks. Plus the US Dollar is strong now and that means you can buy even more foreign shares with your dollar than you could before. That is what I would do, keep your US Stock investments intact but direct new investment monies to International Stocks. If you feel a bit frisky, overweight your International purchases with Emerging Markets.
I'm interested in the argument to purchase International and Emerging Markets equities with the head winds of a strengthening dollar. I'm concerned that currency fluctuations will outweigh any potential gains we see in the European markets.

OP, are you in a similar situation or is your question specific to US markets only. It's hard to imagine that US has fallen enough to warrant a rebalance into domestic equities. Fixed income has outperformed international investments, commodities and gold.
Currency fluctuations are a risk of International investing, but over time these things tend to even out. The case for buying International/Emerging Markets Equities now is pretty simple. First, International Stocks are cheaper compared to US Stocks with a forward P/E of 15 versus 17 for the US Market. Second, a strong US Dollar enables you to buy more shares of International stocks than with a weaker dollar. At some point, the tide will turn and there will be currency tailwinds rather than currency headwinds. It is buying things when they are cheap, that is all.
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Re: rebalancing conundrum/paradox/irony

Post by Rodc » Sun Sep 28, 2014 8:29 am

livesoft wrote:One also has to make peace with losing money. Once you know you are going to lose money and accept that fact, then as an investor you are liberated and have reached freedom.
Agreed. This is very important.
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Re: rebalancing conundrum/paradox/irony

Post by letsgobobby » Sun Sep 28, 2014 9:25 am

You are right that I don't like losing money. I agree I am not at peace with that idea. However, through a process called radical acceptance, I understand that it must and will happen.

But this isn't just about predicting the future or regretting the past. It's about investing in the probabilistically optimal manner over an investing lifetime. Rodc says we'll win some and lose some; retiredjg says when markets crash we'll be able to buy cheaper in the future. Both are true, but neither fact should cause one to withhold investing every available dollar today. Likewise, stocks may go up or down tomorrow, but they are likely to increase over time, which means that the odds are every minute we wait to invest in the stock market means a slightly higher price we will pay for that investment. That would be ok if we didn't have the money to invest today - to Rodc's point, I'm ok with buying at a higher price if I didn't have the money to buy when it was at a lower price. But that's not the case - I did have the money five years ago. And I do have the money available today. Therefore, what is the rationale for investing in a low expected return asset rather than a high expected return asset if I know - barring 25%+ returns ad infinitum - that I will need to buy stocks next year, the year after, the year after that?

notes/caveats/reservations:

- this entire argument only applies to someone who is still early in the accumulation phase, ie has many future years of contributions. Obviously taking this position requires that large declines in the stock market, which are inevitable, not occur just prior to retirement, unless one is so wealthy that a 75% decline in one's portfolio would have no material impact on one's standard of living.

- the end result of this approach is not really any different than the standard advice to be heavily stocks when young, much less so when older. It's a new path to the same destination; it gives additional support to an old idea. Let's not say 100% stocks - let's say 90%, just to keep the peace (it doesn't make a material difference).

- it takes the opposite of a glide path, however - instead of gliding from 90% to 88% to 86% over 5 years, it stays at 90% using all new money to stay in balance until the stock portion of a portfolio has reached the point at which expected, realistic returns of that stock portfolio are sufficient to reach the anticipated terminal value, then all new money goes to bonds, with occasional rebalancing as necessary to maintain the stock projection (ie, if stocks grow much faster than expected there will be rebalancing out of stocks, if they crash then bonds are sold to buy stocks and new money contributed to stocks until the long-term trajectory is reached again).

- obvious big disadvantage is psychology and risk tolerance. This is no different for a young investor who is often already recommended to be 80-90% stocks, but it would be different for a middle-aged investor (gosh, I'm middle aged now) - 40+ years old. It's one thing for a 20 year old with $10,000 to tolerate a 60% loss in stocks; another for a 40 year old with $500,000k to do the same. Many won't have the risk tolerance for this, however some will.

- this is still, I say, a close relative or even a clone of the DCA vs LS argument. DCA is regret-avoiding, it's comforting for those in up and down markets, but most importantly it's the only option for those who make a 401k contribution every 2 weeks for 40 years. But psychology aside, bogleheadism generally recommends lump summing when one has the money - inheritances, front-loading HSAs and 401ks, etc; or at the least, value averaging or dollar cost averaging for a short, defined period of time (6-12 months, for example). We do not recommend DCA a lump sum over 20 years, which would only delay entry into the market and decrease expected returns.

- The biggest risk is that stocks decline and do not recover. This possibility has to be taken seriously, especially for a middle-aged investor (40+), still years from retirement, still dutifully adding to stocks alone/primarily. For example in a deflationary world of 30 year stock declines and bond gains, this investor could be SOL. This is the argument for moving more quickly to some bonds in a traditional asset allocation than this model recommends.

As for me, I have no interest in switching plans now. As livesoft alludes, I will hold my nose and buy what I'm supposed to (international stocks). However the next time PE10 is under 16 I may come back to this (depending on age and portfolio value relative to final goal) and I'll be the guinea pig.

Thanks to all for indulging me, I appreciate the responses.

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Re: rebalancing conundrum/paradox/irony

Post by Buddtholomew » Sun Sep 28, 2014 10:04 am

Ha...I knew it had to do with investing internationally. Not sure why you didn't come out and say that in the OP.
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Re: rebalancing conundrum/paradox/irony

Post by Rodc » Sun Sep 28, 2014 11:09 am

letsgobobby wrote:You are right that I don't like losing money. I agree I am not at peace with that idea. However, through a process called radical acceptance, I understand that it must and will happen.

But this isn't just about predicting the future or regretting the past. It's about investing in the probabilistically optimal manner over an investing lifetime. Rodc says we'll win some and lose some; retiredjg says when markets crash we'll be able to buy cheaper in the future. Both are true, but neither fact should cause one to withhold investing every available dollar today. Likewise, stocks may go up or down tomorrow, but they are likely to increase over time, which means that the odds are every minute we wait to invest in the stock market means a slightly higher price we will pay for that investment. That would be ok if we didn't have the money to invest today - to Rodc's point, I'm ok with buying at a higher price if I didn't have the money to buy when it was at a lower price. But that's not the case - I did have the money five years ago. And I do have the money available today. Therefore, what is the rationale for investing in a low expected return asset rather than a high expected return asset if I know - barring 25%+ returns ad infinitum - that I will need to buy stocks next year, the year after, the year after that?

notes/caveats/reservations:

- this entire argument only applies to someone who is still early in the accumulation phase, ie has many future years of contributions. Obviously taking this position requires that large declines in the stock market, which are inevitable, not occur just prior to retirement, unless one is so wealthy that a 75% decline in one's portfolio would have no material impact on one's standard of living.

- the end result of this approach is not really any different than the standard advice to be heavily stocks when young, much less so when older. It's a new path to the same destination; it gives additional support to an old idea. Let's not say 100% stocks - let's say 90%, just to keep the peace (it doesn't make a material difference).

- it takes the opposite of a glide path, however - instead of gliding from 90% to 88% to 86% over 5 years, it stays at 90% using all new money to stay in balance until the stock portion of a portfolio has reached the point at which expected, realistic returns of that stock portfolio are sufficient to reach the anticipated terminal value, then all new money goes to bonds, with occasional rebalancing as necessary to maintain the stock projection (ie, if stocks grow much faster than expected there will be rebalancing out of stocks, if they crash then bonds are sold to buy stocks and new money contributed to stocks until the long-term trajectory is reached again).

- obvious big disadvantage is psychology and risk tolerance. This is no different for a young investor who is often already recommended to be 80-90% stocks, but it would be different for a middle-aged investor (gosh, I'm middle aged now) - 40+ years old. It's one thing for a 20 year old with $10,000 to tolerate a 60% loss in stocks; another for a 40 year old with $500,000k to do the same. Many won't have the risk tolerance for this, however some will.

- this is still, I say, a close relative or even a clone of the DCA vs LS argument. DCA is regret-avoiding, it's comforting for those in up and down markets, but most importantly it's the only option for those who make a 401k contribution every 2 weeks for 40 years. But psychology aside, bogleheadism generally recommends lump summing when one has the money - inheritances, front-loading HSAs and 401ks, etc; or at the least, value averaging or dollar cost averaging for a short, defined period of time (6-12 months, for example). We do not recommend DCA a lump sum over 20 years, which would only delay entry into the market and decrease expected returns.

- The biggest risk is that stocks decline and do not recover. This possibility has to be taken seriously, especially for a middle-aged investor (40+), still years from retirement, still dutifully adding to stocks alone/primarily. For example in a deflationary world of 30 year stock declines and bond gains, this investor could be SOL. This is the argument for moving more quickly to some bonds in a traditional asset allocation than this model recommends.

As for me, I have no interest in switching plans now. As livesoft alludes, I will hold my nose and buy what I'm supposed to (international stocks). However the next time PE10 is under 16 I may come back to this (depending on age and portfolio value relative to final goal) and I'll be the guinea pig.

Thanks to all for indulging me, I appreciate the responses.
So why is that not your plan?

There are always multiple rational paths. But you can really only follow one. Pick one, follow it, try not to lose too much sleep dreaming of "What if only..." The problem is not so much having a modestly suboptimal plan, but having a horrible plan or no plan (if you reassess and change your plan frequently that is the same as no plan).

Best of luck.
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Re: rebalancing conundrum/paradox/irony

Post by retiredjg » Sun Sep 28, 2014 11:16 am

letsgobobby wrote:...I'm ok with buying at a higher price if I didn't have the money to buy when it was at a lower price. But that's not the case - I did have the money five years ago. And I do have the money available today. Therefore, what is the rationale for investing in a low expected return asset rather than a high expected return asset if I know - barring 25%+ returns ad infinitum - that I will need to buy stocks next year, the year after, the year after that?
This thinking might work for some, but for anyone who has an aversion to risk, this is not a good idea.

It works on paper, especially if there is no crash. It works on paper when you can look back at what did happen. It may not work in real life when things actually do go downhill.

I do not believe this plan would have worked for you back when you started here. Well, it might have worked since the last 5 years has been a continuous upward climb, but that would have been sheer dumb luck.

I'm glad to hear you are planning to stick with your plan. It's a good one.

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Re: rebalancing conundrum/paradox/irony

Post by adam1712 » Sun Sep 28, 2014 1:06 pm

I think you've hit on a key point about glidepaths of asset allocation. If somebody has 30 years to invest and wants to invest in stocks and some 0 risk asset, the optimal way to do it is to always have the same amount invested in stocks every year. Taking gains off the table when stocks go up and buying stocks when they go down. That way a bad year has an equal effect on the end result no matter what year it happens.

In reality, it's nearly impossible for somebody saving for retirement to do it. It was the whole justification MarketTimer used for leverage in his infamous "A different approach to asset allocation" thread. Psychologically it's very difficult and then life can always get in the way such that the next 30 years may not play out like you like (job loss, disability, poor economic conditions, etc).

It's especially tough to understand the risks when you're first starting out and so I think the standard age in bonds works pretty well. But there's often this crazy sentiment that you should be rooting for stocks to go down when you're young which to me is a clear indication your asset allocation isn't risky enough now and will be too risky later. The bottom line is you have to find a plan that works for you, but realizing the difference in risk between a large stock portfolio right before retirement and a smaller stock portfolio now is an important thing to understand.

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Re: rebalancing conundrum/paradox/irony

Post by grayfox » Mon Sep 29, 2014 2:09 am

letsgobobby wrote:long story short:

For years I've been 60/40, with 90%+ of all new contributions going to fixed income. This has worked because the stock market is going up 25% per year for the last five years, so my portfolio stays balanced. Really haven't had to rebalance at all during that period of time.

But in 2014 the stock market is up much less - small caps are down, total market up single digits. As a result, stock gains aren't sufficient to keep portfolio in balance so I'm becoming overweighted in fixed income.

If this continues I'll have to use new contributions to buy stocks, if I want to follow my IPS and maintain my portfolio's risk profile. The paradox is my risk-managing IPS is now requiring me to buy more risky assets for the first time in 5+ years, after those risky assets have doubled or tripled in value while the less risky assets have gone up 20-30%.

This seems very counterintuitive to me...
Interesting. This illustrates another logical inconsistency with the recommended practice of maintaining a policy portfolio by rebalancing.

Decades ago, Bill Sharpe wrote that it was impossible for everyone to rebalance by selling stocks when they go up. Yet the recommended advice is for everyone to rebalance by selling stocks when they go up. Clearly there is something wrong with this advice.

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Re: rebalancing conundrum/paradox/irony

Post by Bmac » Mon Sep 29, 2014 4:12 am

inbox788 wrote:
letsgobobby wrote:
rkhusky wrote: When stocks are dropping you have to buy more stocks.
Agree, but that's not what's happening here. Stocks continue to rise to all time record highs, but not fast enough to offset fixed income contributions/gains.

Is my risk determined by the percentage of portfolio invested in risky assets, or by dollar amount invested in risky assets?

In other words, if I knew I was always going to have to buy more stocks in the future barring 25%+ returns forever, why didn't I just do it five years ago, four years ago, etc? I had the money and instead invested it in bonds.

Likewise it appears I will have to continue to buy more stocks in the future, as well. For example if I have $600k in stocks and $400k in bonds now and I predict when I retire I will have $1200k in stocks and $800k in bonds, shouldn't all $1000k that I have now be in stocks? I should buy now, at a presumably lower price, all the risky assets I will ever plan to own/buy in the future, if I have the money. Then I should sell those (presumably) appreciated assets once I hit the $1200k target, and build low risk assets in that manner and at that time.
In general AA is determined by the percentage. You're mixing your AA and investment strategy/rebalancing strategy. And you've got your cart before your horse if you're looking at future projections. Begin with your AA today and align it with your desired AA of 60/40. If the market drops, so your AA is now 55/45, you rebalance by selling bonds and buying stocks. If the market rises (as it seems it has for your) AA goes to 65/35, you sell stocks and buy bonds.

So what do you do with new money? Easy, invest it in a 60/40 AA. What you've been doing is instead of selling stocks and buying bonds to rebalance AND buying 60/40 bonds AND stocks, you've pretty much cancelled out the selling and buying of stocks and just added bonds to keep AA even. In a year when stocks and bonds gain evenly or bonds outperform stocks, you still rebalance AND invest new money in a 60/40 AA. This may mean the net effect is to buy stocks.

http://www.bogleheads.org/wiki/Asset_allocation

http://www.bogleheads.org/wiki/Rebalancing
Rebalancing is the action of bringing a portfolio that has deviated away from one's target asset allocation back into line. The objective is to maintain a consistent mix of asset classes (most commonly equities vs. fixed income) in order to control risk at the level desired by the investor. This is accomplished by transferring funds from higher-performing classes to lower-performing classes. While potentially counterintuitive, rebalancing ensures that investors "Buy Low" and "Sell High".
+1 I think Inbox788 nailed it. You are not really rebalancing. You are investing new money to maintain your desired asset allocation. Now when the next bad bear market hits, you might be forced to really rebalance and sell bonds to buy equities.

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Re: rebalancing conundrum/paradox/irony

Post by grayfox » Mon Sep 29, 2014 4:51 am

It seems to me that the OP followed one of the BH rebalancing strategies in the wiki on Rebalancing
Different rebalancing approaches
There are a variety of ways in which investors determine it is time to rebalance:

When contributing to or withdrawing from your portfolio. For example, if your target allocation is 60% equities and 40% fixed income, you hold $7000 of equities and $3000 of fixed income, and you wish to contribute $1000 to your portfolio, you would simply buy $1000 worth of fixed income assets. This would bring you to an allocation of 64% equities / 36% fixed income. This approach minimizes transaction costs, effort, and taxes. This portfolio rebalancing calculator can help in cases where it isn't obvious how much of a new contribution or withdrawal to allocate to each asset.

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