Is rebalancing bunk?

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Johnnie
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Is rebalancing bunk?

Post by Johnnie » Sat Jan 28, 2017 9:52 am

Excerpts from Robert Powell in the WSJ, "Portfolio Rebalancing Might Be Overrated":
...Most recently, in an article published in Advisor Perspectives, Michael Edesess, chief investment strategist at Compendium Finance, suggests that rebalancing is no better or worse a strategy than buy-and-hold. Each has advantages, depending on the circumstances, he says.

Any claims that rebalancing offers a bonus or excess return, compared with using a buy-and-hold strategy, “are mistaken...”

...Edesess cites research by himself and others that concludes that when two or more types of assets are present in a portfolio and the returns of those assets differ by only a small amount—which happens about two-thirds of the time, he adds—rebalancing will slightly outperform buy-and-hold. But if their performance diverges by more than a small amount, Dr. Edesess says, “then buy-and-hold will greatly outperform rebalancing.”

...In his article, he further argues that the academic investment community, in claiming an overall financial advantage for rebalancing, is misleadingly selective with the related research data. What mathematical research on the subject shows, he says, is that an outcome in which rebalancing exhibits an advantage is but one possibility in a range of possible outcomes governed by the laws of chance. If one looks at an average of all the possible outcomes, he says, it is clear that neither strategy has an advantage.

Earlier research cited by Dr. Edesess, by Andrew Wise, a former actuary with a global consulting firm, also found no clear advantage between the two strategies. Mr. Wise, whose paper on the subject was published in the British Actuarial Journal in 1996, says he and Dr. Edesess are in agreement.

There are other skeptics about the wisdom of rebalancing as well. Michael Falk, a chartered financial analyst, author and partner at Focus Consulting, says rebalancing makes two false assumptions: One, that all securities are cyclical and regress to a mean. “Some securities fall and can’t get back up,” Mr. Falk says. And two, that all regressions to the mean take the same amount of time. “Hence, rebalancing cannot be assumed to always add value,” he concludes.

Regular rebalancing still has many defenders, of course...
http://www.wsj.com/articles/portfolio-r ... 1483931101
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Re: Is rebalancing bunk?

Post by livesoft » Sat Jan 28, 2017 9:55 am

Discussed at length in this other thread:
viewtopic.php?t=207974

From that thread:
His [Edesess] article is consistent with all the rebalancing threads and ideas at Bogleheads.org.
Be wary of journalist interpretations of articles.

Another legitimate interpretation is that one should use rebalancing trigger points to increase or decrease risk in one's portfolio. Increasing risk is expected to lead to higher returns while decreasing risk is expected to lead to lower returns.
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Re: Is rebalancing bunk?

Post by tadamsmar » Sat Jan 28, 2017 10:10 am

That article does not even mention the main reason Bogleheads re-balance.

Also, the article used the term mean reversion without defining it. It has multiple meanings.

The only goal the article discusses is getting a larger return. But you can get that by increasing your risk to a pretty high level. Most investors are interested in limiting risk and getting the highest return at a limited risk level.

The statement "rebalancing makes two false assumptions: One, that all securities are cyclical and regress to a mean." is not true.

Most Bogleheads, including me, rebalance to limit risk because the stock/bond ratio will become more stock heavy so that the overall AA will become more risky over decades of investing.

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Re: Is rebalancing bunk?

Post by Johnnie » Sat Jan 28, 2017 10:29 am

tadamsmar wrote: That article does not even mention the main reason Bogleheads re-balance.

Most Bogleheads, including me, rebalance to limit risk because the stock/bond ratio will become more stock heavy so that the overall AA will become more risky over decades of investing.
Me too, but it never hurts to periodically check my premises.
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Re: Is rebalancing bunk?

Post by SGM » Sat Jan 28, 2017 10:31 am

I kept my AA at 100% stock for 25+ years. I don't bother back testing anything or second guess myself. I was satisfied with my returns and was not concerned with risk. If the market was low I was buying more shares with the same amount of investments each month. Now that I am retired I am happy with 25-30% bonds plus fixed income streams. I may add SPIAs in the future, but I am not worked up over rebalancing one way or the other. I will rebalance if things get way out of whack, but not for increased return but to decrease risk. To my mind that means rebalancing to increase bonds not stocks at this stage.

If I had fewer income streams I would probably be closer to 60/40 or even 50/50.

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Re: Is rebalancing bunk?

Post by dbr » Sat Jan 28, 2017 10:35 am

tadamsmar wrote:
Most Bogleheads, including me, rebalance to limit risk because the stock/bond ratio will become more stock heavy so that the overall AA will become more risky over decades of investing.
For sure. I have never viewed rebalancing as anything other than simple and obvious common sense to keep one's asset allocation roughly where it is intended. I don't see trying to turn this into some esoteric tool of portfolio management.

Others may have some different purpose in mind, justified or not.

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Re: Is rebalancing bunk?

Post by arcticpineapplecorp. » Sat Jan 28, 2017 10:37 am

In this same article, which you did not quote, Dr. Bernstein says it best:
“One rebalances to reduce risk, not increase return,” says William Bernstein, the author of “The Investor’s Manifesto.” As proof, Mr. Bernstein says, “just ask the retirees who didn’t rebalance in 2000.”
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Re: Is rebalancing bunk?

Post by Sandtrap » Sat Jan 28, 2017 10:50 am

Given that "rebalancing" towards one predetermined Asset Allocation mitigates risk . . . .
and given that one might change that Asset Allocation according to evolving personal needs and circumstance. . . .
Is it reactive to change the target Asset Allocation to adjust to long term market trends?
Last edited by Sandtrap on Sat Jan 28, 2017 6:19 pm, edited 1 time in total.
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Re: Is rebalancing bunk?

Post by plannerman » Sat Jan 28, 2017 11:13 am

I rebalance primarily to control risk. Which means, in "normal" times, selling equities and buying fixed income. However, those of us who rebalanced from fixed income into equities in 2008 and 2009, which by-the-way was one of the more difficult things I have done in a lifetime of investing, reaped a huge "rebalancing bonus" vis-a-vis buy and hold.

plannerman

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Re: Is rebalancing bunk?

Post by knpstr » Sat Jan 28, 2017 11:22 am

plannerman wrote:I rebalance primarily to control risk. Which means, in "normal" times, selling equities and buying fixed income. However, those of us who rebalanced from fixed income into equities in 2008 and 2009, which by-the-way was one of the more difficult things I have done in a lifetime of investing, reaped a huge "rebalancing bonus" vis-a-vis buy and hold.
If you rebalanced on the way down, did you not also rebalance on the way back up??
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Re: Is rebalancing bunk?

Post by Phineas J. Whoopee » Sun Jan 29, 2017 1:25 am

Johnnie wrote:Excerpts from Robert Powell in the WSJ, "Portfolio Rebalancing Might Be Overrated":
...
Any claims that rebalancing offers a bonus or excess return, compared with using a buy-and-hold strategy, “are mistaken...”
...
As are any claims that cinder blocks will benignly float in the atmosphere without falling on us.

It's too bad the Journal has to publish stories pointing it out, but I can't argue with its editors for doing so. If somebody wants the returns, potentially negative over their investing lifetime, of a 100% equity portfolio they should just hold one, rather than fantasize about rebalancing bonuses and higher returns with lower risk.

The Journal's target audience includes captains of industry.

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Re: Is rebalancing bunk?

Post by stemikger » Sun Jan 29, 2017 8:31 am

I didn't read the other replies yet, but I would like to add.

John Bogle does not rebalance. Just a thought.

I personally do it once a year with my very complicated two fund portfolio (Vanguard Institutional Index and Blackrock U.S. Debt Index).

I also own a small IRA with the Vanguard Balanced Index Fund which does it on its own.
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Re: Is rebalancing bunk?

Post by RadAudit » Sun Jan 29, 2017 9:37 am

Sandtrap wrote: Is it reactive to change the target Asset Allocation to adjust to long term market trends?
Probably not. As long as it meets your evolved personal needs and circumstance.
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Re: Is rebalancing bunk?

Post by galeno » Sun Jan 29, 2017 9:44 am

Rebalance to control shallow risk. Period.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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Re: Is rebalancing bunk?

Post by nisiprius » Sun Jan 29, 2017 9:49 am

"Rebalancing" is a description of doing something, so it can't be bunk. The question is whether "Are claims made for the benefits of rebalancing bunk?" And the reason this question is so slippery is that there isn't any general agreement among proponents of rebalancing as to benefits are actually claimed.

What's bunk is to suppose that rebalancing can manufacture extra risk-adjusted return out of the thin air of pure volatility, without any mean reversion. Imagine a pair of companions playing roulette at a casino. Suppose that instead of playing individually, they agree that every hour they will pause, pool their money, and split it 50/50. Do you think this change the house percentage? The wheel is still going to stop on 0 and 00 two out of thirty-eight spins. Perhaps, to make it clearer, we might imagine the casino operates a fair roulette wheel (1-36, no 0, no 00). (Are such wheels even manufactured, I wonder?) In this case, their (mathematical!) expectation, playing separately, is zero. Do you believe that they will change this to a positive expected return by playing in partnership?

I find that we (or at least I) constantly struggle with a false mental model of what rebalancing does. For example, consider rebalancing between stocks and bonds during the time period 2008-2011. I'm too lazy to calculate real numbers here so just take this as a sketch. I'm going to use red dots to indicate a purchase of stock and green dots to indicate a sale.

When we think of rebalancing, I find it almost irresistible to picture this mentally in terms of buying somewhere near the bottom. I'm realistic enough to know that a rebalancing rule (by calendar or by percentage changes or both) won't find the exact bottom, nor sell at the precise top, but nevertheless I fantasize that it will be something like this:

Image

In fact, if our rebalancing rule triggers fairly often, it will look more like this. Now, to determine overall gain or loss we need to look at completely round-trip transactions, buy then sell. We can pair them up any way we like. Here, I've chosen to pair each purchase with the closest corresponding sale. Again, I'm just drawing this by hand, so I could be deceiving myself or you, just in a complicated way, and someday I hope to get around to doing some actual computer simulations, but this is the idea:

Image

The idea I want to convey here is not whether there's an overall gain or loss, but that it is complicated. I'm not trying to illustrate any pattern, I'm just trying to give the idea of a ladder with rungs sloping different amounts. Some of the paired transactions will represent gains, some will represent losses, and each of them will be relatively small. It's not a slam-dunk big gain, bought almost at the bottom, sold almost at the top. You'll have a total of a lot of small gains and losses, and which way it goes will depend somewhat on the luck of the draw as to the exact moments when the rule triggered on the way down and the way up.

The third possibility is that you follow a strict rebalancing rule of some kind that is intended not to fire too often, so as to resonate with mean reversion or whatever. The problem with this is that, once again, when we try such rules, they don't fire at the bottom. Just as with market timing rules, they get tripped up by apparent weird coincidences--you said you'd buy on an X% drop, but whatever you're measuring drops just short of that; or, it rises, "deceptively," just enough to trigger a sale, only to suddenly rise much further so you miss out on most of the potential gain. Because it doesn't fire very often, it's another game of relatively small samples of time to look at--and a real danger of overfitting by "improving" the rules so that they happen to perform well on the particular bit of history you're looking at.

As I look overall at e.g. the evidence presented by Siegel in Stocks for the Long Run, the conclusion I come to is that there's good evidence for some mean reversion, but it's not that huge an effect, nor is its timing predictable enough to synchronize to. In fact, I think the last word on the subject might have been said in 1937 by Cowles and Jones, in a peer-reviewed paper Econometrica, which found definite evidence of both short-term momentum ("inertia," they called it) and mean reversion on about a five-year time scale ("reversals," they called them)--but, after saying "This evidence of structure in stock prices suggests alluring possibilities in the way of forecasting," proceeded to spend thirteen pages examining systems for exploiting it, only to conclude that
This type of forecasting could not be employed by speculators with any assurance of consistent or large profits.
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Re: Is rebalancing bunk?

Post by dbr » Sun Jan 29, 2017 9:56 am

Thanks, nisi, for an excellent explanation and good drawings. Every time I read someone talking about making a killing by rebalancing those pictures dance in my head, but I have never actually drawn them out and posted them.

I think there have been enough studies of any possible rebalancing bonus to show that there is no windfall here or even a worthwhile benefit. There can be random benefits or losses depending on time points. So rebalancing IS bunk.

In the meantime the whole rationale that one is simply trying to keep the asset allocation one intended all along is constantly overlooked. So rebalancing IS NOT bunk.

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Re: Is rebalancing bunk?

Post by nisiprius » Sun Jan 29, 2017 10:07 am

Yes... if we assume that risk tolerance means something. I dislike Edesess' fairly interesting article, which may or may not be the one being referred to in the original post, The Academic Failure to Understand Rebalancing, because although he seems to acknowledge that "buy and hold," without rebalancing, increases the dispersion of outcomes, he doesn't seem to stress this. He doesn't address the question of risk-adjusted return. It seems obvious (?) that buying and holding for a very long period of time without rebalancing is going to result in a higher average stock allocation, and thus a higher dispersion of outcomes (risk) to go along with higher return.

Anyway, if we take risk tolerance seriously enough that we feel that we can judge one of the four LifeStrategy funds as being OK, and the other three as either "too risky" or "not risky enough"--that is to say, we want to keep our stock allocation within a range of about ±10% of total portfolio--then actual math shows that during an extended bull market like 1995-2000, yes, we need to rebalance once or twice. Incidentally, reasonable assumptions lead consistently to the idea that, if the goal is keeping a stable level of portfolio risk, you only need to rebalance every three-to-five years or so.

I think rebalancing could get oversold because, as a slightly burdensome chore, it represents is a visible service an advisor can perform, thus justifying fees. And yes, it is slightly burdensome. I must confess that every time I try it myself, I spend fifteen minutes with a spreadsheet and/or calculator--and then, after I do it, I often find that I've made a small goof. Not big enough to bother correcting, but, say, ending up with 24.4% of my stocks being international when I meant it to be 25.0000%.
Last edited by nisiprius on Sun Jan 29, 2017 10:11 am, edited 1 time in total.
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Re: Is rebalancing bunk?

Post by livesoft » Sun Jan 29, 2017 10:10 am

I agree with what Nisiprius wrote.

If one wants higher expected return, then one will need to increase their allocation to equities above their normal asset allocation to equities.
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Re: Is rebalancing bunk?

Post by iceport » Sun Jan 29, 2017 10:36 am

To counter all those piling on to condemn the "re-balancing bonus" as "bunk," consider that re-balancing between high risk/high volatility assets and low risk/low volatility assets could produce a different expected result than re-balancing among only high risk/high volatility assets with low correlation.

From Bill Bernstein:

THE REBALANCING BONUS: Theory and Practice

This seems to mirror, for example, Rick Ferri's work that showed an advantage in holding separate allocations to developed European and developed Asian/Far East markets, and re-balancing between them, over holding a combined EAFE index fund.
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Re: Is rebalancing bunk?

Post by CULater » Sun Jan 29, 2017 11:05 am

The major purpose of rebalancing is to maintain a static asset allocation, which has the effect of trimming back the allocation to the highest returning asset (typically stocks) in favor of the lowest returning assets. This only makes sense if the highest returning asset is the most volatile asset, in order to reduce potential drawdowns. However, the dollar impact of drawdowns is an increasing function of portfolio size. This means that rebalancing might mean more in the later years of accumulation, when the portfolio is larger, than in the early stages when the portfolio is small.

However, investors should generally be systematically shifting their asset allocation toward a more conservative allocation anyway as they age and have less human capital. It really makes sense for investors to be heavily weighted toward stocks during the first part of their accumulation period (as much as 100%), and rebalancing has little effect in this case. During the latter part of their accumulation period, say age 50 or so, the investor should be changing their allocation systematically in favor of more conservative assets. This isn't rebalancing; it is a systematic shift in allocation policy.
I find the idea of rebalancing to be sort of superfluous. The principal objective is to have the appropriate allocation at each given stage of the portfolio management process.
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Re: Is rebalancing bunk?

Post by KlangFool » Sun Jan 29, 2017 11:12 am

Sandtrap wrote:Given that "rebalancing" towards one predetermined Asset Allocation mitigates risk . . . .
and given that one might change that Asset Allocation according to evolving personal needs and circumstance. . . .
Is it reactive to change the target Asset Allocation to adjust to long term market trends?
Sandtrap,

How do you know what the long-term market trend is?

You don't. Hence, it is pointless to adjust your AA based on the long-term market trend. It is pure speculation.

KlangFool

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Re: Is rebalancing bunk?

Post by nedsaid » Sun Jan 29, 2017 11:25 am

I rebalance for a couple of reasons. First, was regret I felt during the 2008-2009 financial crisis and bear market. I had let my stock allocation drift upwards to 72% and I missed the opportunity to harvest gains to buy bonds. I let my portfolio drift into a too stock heavy and risk heavy allocation. Second, after admitting my rather relaxed attitude towards rebalancing, I pretty much was shamed into it. I felt like I was not practicing proper portfolio hygiene. Rebalancing around here is sort of like brushing, flossing, and using a good dental rinse. Rebalancing like cleanliness, is pretty much like Godliness around here.
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Re: Is rebalancing bunk?

Post by Toons » Sun Jan 29, 2017 11:28 am

I let the market rebalance for me.
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Re: Is rebalancing bunk?

Post by Dottie57 » Sun Jan 29, 2017 11:30 am

plannerman wrote:I rebalance primarily to control risk. Which means, in "normal" times, selling equities and buying fixed income. However, those of us who rebalanced from fixed income into equities in 2008 and 2009, which by-the-way was one of the more difficult things I have done in a lifetime of investing, reaped a huge "rebalancing bonus" vis-a-vis buy and hold.

plannerman
Rebalancing also enforces to some degree, Buy low, sell high.

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Re: Is rebalancing bunk?

Post by nedsaid » Sun Jan 29, 2017 11:31 am

Toons wrote:I let the market rebalance for me.
:happy
I did too in 2008-2009 and didn't like it one darned bit! :wink: Either you rebalance your portfolio or the markets will do it for you.
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Re: Is rebalancing bunk?

Post by Toons » Sun Jan 29, 2017 11:34 am

nedsaid wrote:
Toons wrote:I let the market rebalance for me.
:happy
I did too in 2008-2009 and didn't like it one darned bit! :wink: Either you rebalance your portfolio or the markets will do it for you.


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Re: Is rebalancing bunk?

Post by CULater » Sun Jan 29, 2017 11:41 am

Just use a target fund and forgeddabouddit.
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Re: Is rebalancing bunk?

Post by Johnnie » Sun Jan 29, 2017 12:15 pm

Question for Nisi (or whoever):

Focusing on just the A/A adjusting aspect, what rebalance strategy would you regard a sensible and "good enough" in a bogle-esque "keep it simple" manner? Annual? Biannual? Rate bands? Other?

Or to put it another way, is there any good reason do anything other than simply rebalance once a year at about the same time each year?
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Re: Is rebalancing bunk?

Post by dbr » Sun Jan 29, 2017 12:30 pm

Johnnie wrote:Question for Nisi (or whoever):

Focusing on just the A/A adjusting aspect, what rebalance strategy would you regard a sensible and "good enough" in a bogle-esque "keep it simple" manner? Annual? Biannual? Rate bands? Other?

Or to put it another way, is there any good reason do anything other than simply rebalance once a year at about the same time each year?
I prefer bands. One reason is that it is not useful to rebalance if you are close enough to target. Secondly bands will be triggered surprisingly seldom. Once a year is probably too frequent. Also, you don't have to watch everything with an eagle eye. A few months with things a little off will matter not at all.

These comments are for those who want to just keep things generally in line. I would not address slice and dice portfolio efficiency.

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Re: Is rebalancing bunk?

Post by Sandtrap » Sun Jan 29, 2017 12:31 pm

KlangFool wrote:
Sandtrap wrote:Given that "rebalancing" towards one predetermined Asset Allocation mitigates risk . . . .
and given that one might change that Asset Allocation according to evolving personal needs and circumstance. . . .
Is it reactive to change the target Asset Allocation to adjust to long term market trends?
Sandtrap,

How do you know what the long-term market trend is?

You don't. Hence, it is pointless to adjust your AA based on the long-term market trend. It is pure speculation.

KlangFool
Very very true. And anti-Bogleheadish.
However, is it the same "concept" in a smaller scale to adjust "auto reinvestment of dividends and interest" on given funds according to present trends? IE: deep ocean currents, wind chop swells rising to 20 feet? :confused
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Re: Is rebalancing bunk?

Post by Ari » Sun Jan 29, 2017 12:48 pm

tadamsmar wrote:Most Bogleheads, including me, rebalance to limit risk because the stock/bond ratio will become more stock heavy so that the overall AA will become more risky over decades of investing.
And yet, time and time again I see the "dry powder argument" for bonds in Bogleheads threads. As in "It's good to keep some bonds in order to have some dry powder left in the keg to invest when the stock markets crash." It's common enough here that I'd say there seems to be a significant subsets of Bogleheads that believe in a rebalancing bonus for bonds vs. stocks.
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Re: Is rebalancing bunk?

Post by KlangFool » Sun Jan 29, 2017 12:52 pm

Sandtrap wrote:
KlangFool wrote:
Sandtrap wrote:Given that "rebalancing" towards one predetermined Asset Allocation mitigates risk . . . .
and given that one might change that Asset Allocation according to evolving personal needs and circumstance. . . .
Is it reactive to change the target Asset Allocation to adjust to long term market trends?
Sandtrap,

How do you know what the long-term market trend is?

You don't. Hence, it is pointless to adjust your AA based on the long-term market trend. It is pure speculation.

KlangFool
Very very true. And anti-Bogleheadish.
However, is it the same "concept" in a smaller scale to adjust "auto reinvestment of dividends and interest" on given funds according to present trends? IE: deep ocean currents, wind chop swells rising to 20 feet? :confused
Sandtrap,

I do not do any of those. I divert my dividend and interest income into whatever is low in term of my AA. It is strictly by the spreadsheet. Ditto on the new contribution.

In fact, I do not waste my time reading those "news". If you are interested in real news, check out below:

http://www.stratfor.com

KlangFool

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Re: Is rebalancing bunk?

Post by hoops777 » Sun Jan 29, 2017 12:57 pm

Has there been any studies done on how balanced funds perform vs people who rebalance on their own?
K.I.S.S........so easy to say so difficult to do.

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Re: Is rebalancing bunk?

Post by goingup » Sun Jan 29, 2017 1:15 pm

nisiprius wrote:Incidentally, reasonable assumptions lead consistently to the idea that, if the goal is keeping a stable level of portfolio risk, you only need to rebalance every three-to-five years or so.

I think rebalancing could get oversold because, as a slightly burdensome chore, it represents is a visible service an advisor can perform, thus justifying fees.
I agree with all of this. Rebalancing is fine to do every several years. Wm Bernstein has said this, too. Jack Bogle has said there is no need for slavish rebalancing. Taylor has suggested 10% rebalancing bands for stock/bonds.

Personally, I think people want to tinker with their portfolios so they make a big deal of it. As accumulators, we are adding about 5% to our portfolio each year and just direct where it needs to go to keep a loose 60/40 balance. No fanfare required.

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Re: Is rebalancing bunk?

Post by CULater » Sun Jan 29, 2017 1:31 pm

Rebalancing can make you subject to "sequence of returns" risk, particularly in the later stages of portfolio accumulation when it has grown to a large size relative to new contributions. Mathematically, a lump sum invested at Time 1 will grow to the same ending value at Time 2 regardless of the sequence of returns in between. It won't make any difference whether losses are experienced at the beginning, the middle, or the end of the time period. In the latter stages of accumulation, one's portfolio returns start to increasingly resemble the returns of a lump sum investment.

Now, when you start jiggering with a lump-sum investment it becomes vulnerable to the sequence-of-returns risk of the assets constituting it. For example, if you move a significant amount of money from stocks to bonds the ending value of your portfolio will become much more dependent on the stock sequence of returns. If they do well after you "rebalanced" into stocks, the sequence worked in your favor; if they don't do well, the sequence worked against you. Same for the bond allocation.

In order to minimize sequence-of-returns risk, one should set a given portfolio allocation at the start and not tamper with the portfolio by shifting funds between assets. The only reason to shift money between assets is that the initial portfolio allocation is no longer appropriate; for example I'm within 10 years of retirement and wish to reduce my policy allocation to stocks to 45% (age in bonds) or even lower. In the meantime, leave it alone! Or, perhaps when you are within 10 years of retirement, consider using the asymmetric re-balancing strategy; if the stock allocation has grown large relative to the policy allocation, then sell stocks to buy bonds. However, if the bond allocation has grown larger, then do not rebalance into stocks. Stocks have too much sequence risk to gamble near retirement by buying more.
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Re: Is rebalancing bunk?

Post by tadamsmar » Sun Jan 29, 2017 1:55 pm

If you look at investing in terms of the Kelly Criteria (the subject of the book Fortune's Formula]), rebalancing amounts to ensuring that you keep betting the same fraction of your stock allocation year after year. You don't let your fraction increase or decrease based on the sequence of past winning or losing years.

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Re: Is rebalancing bunk?

Post by Sandtrap » Sun Jan 29, 2017 2:09 pm

CULater wrote:Rebalancing can make you subject to "sequence of returns" risk, particularly in the later stages of portfolio accumulation when it has grown to a large size relative to new contributions. Mathematically, a lump sum invested at Time 1 will grow to the same ending value at Time 2 regardless of the sequence of returns in between. It won't make any difference whether losses are experienced at the beginning, the middle, or the end of the time period. In the latter stages of accumulation, one's portfolio returns start to increasingly resemble the returns of a lump sum investment.

Now, when you start jiggering with a lump-sum investment it becomes vulnerable to the sequence-of-returns risk of the assets constituting it. For example, if you move a significant amount of money from stocks to bonds the ending value of your portfolio will become much more dependent on the stock sequence of returns. If they do well after you "rebalanced" into stocks, the sequence worked in your favor; if they don't do well, the sequence worked against you. Same for the bond allocation.

In order to minimize sequence-of-returns risk, one should set a given portfolio allocation at the start and not tamper with the portfolio by shifting funds between assets. The only reason to shift money between assets is that the initial portfolio allocation is no longer appropriate; for example I'm within 10 years of retirement and wish to reduce my policy allocation to stocks to 45% (age in bonds) or even lower. In the meantime, leave it alone! Or, perhaps when you are within 10 years of retirement, consider using the asymmetric re-balancing strategy; if the stock allocation has grown large relative to the policy allocation, then sell stocks to buy bonds. However, if the bond allocation has grown larger, then do not rebalance into stocks. Stocks have too much sequence risk to gamble near retirement by buying more.
Thank you for the clarity.
So given the above, it would be prudent to "rebalance" yearly or such, to match the evolving allocation to "ones age in bonds", and correct me here, retain that AA if one would annuitize some of those assets via SPIA, or laddered SPIA over time.
Is this true?
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Re: Is rebalancing bunk?

Post by Sandtrap » Sun Jan 29, 2017 2:11 pm

KlangFool wrote: . . . . .

I do not do any of those. I divert my dividend and interest income into whatever is low in term of my AA. It is strictly by the spreadsheet. Ditto on the new contribution.

In fact, I do not waste my time reading those "news". If you are interested in real news, check out below:

http://www.stratfor.com

KlangFool
I agree. Thanks for the confirmation on "reinvestment of dividends and interest".
thanks for the news link.
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Re: Is rebalancing bunk?

Post by livesoft » Sun Jan 29, 2017 2:15 pm

Sandtrap wrote:So given the above, it would be prudent to "rebalance" yearly or such, to match the evolving allocation to "ones age in bonds", and correct me here, retain that AA if one would annuitize some of those assets via SPIA, or laddered SPIA over time.
Is this true?
livesoft wrote:The best way to rebalance will be a combination of every possible way and will depend on the circumstances and your tax situation.

In the taxable account, I would have (and do have) 100% equities as long as bond funds fit into my tax-deferred account. I do tax loss harvesting when warranted and have built up carryover losses so that if I had to rebalance in taxable, then I would not have any taxes to do so.

In Roth accounts where I hold mostly equities, I rarely do any rebalancing, but it still happens. For instance, if I see that emerging markets small-caps have dropped a lot, then I overweight emerging markets small-caps in Roths and underweight Total US Market, but if EM small-caps have gone way up, then I underweight EM small-cap in Roth and overweight Total US Market. I make corresponding changes in tax-deferred to keep portfolio total AA in balance. Also note that this is NOT calendar based.

In tax-deferred accounts, I actually do all my rebalancing between equities and bonds (except for a little bit in Roths). I rebalance based on current dollar amounts and not based on a calendar. That way when something drops 10% in two days (can you say "Brexit"?), then I do not sit on my butt and think "Oh, I can't rebalance now because the calendar says don't rebalance). But if my AA is out of whack to the high side (too many equities), then I have a hard trigger limit and rebalance, too, by selling equities to buy bonds. I do not rebalance back down to the middle of my range, but instead only back to somewhere higher than middle and below the hard trigger.

Then since a lot of dividends are paid in late December, I take those dividends in cash and manually invest them. Of course, I invest them in an act of rebalancing. In effect, that's a calendar-based rebalancing. And I do this to a lesser extent when dividends are paid at the end of other quarters.

If my tax-deferred accounts were 100% bonds, then I would add bonds to Roth (minimal) and taxable (tax-exempt munis) and carry on.

Bottom line: Don't get trapped into thinking that there is one single best method to rebalance and don't get trapped into thinking that one can only use one method of rebalancing. However, don't pay transactions fees nor taxes nor any other costs to rebalance because it is so easy to avoid all those things. Just inject some common sense (instead of conventional wisdom) into your decisions.
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Re: Is rebalancing bunk?

Post by greg24 » Sun Jan 29, 2017 2:19 pm

The original article didn't use a click-bait headline.

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Re: Is rebalancing bunk?

Post by Sandtrap » Sun Jan 29, 2017 2:20 pm

livesoft wrote:
Sandtrap wrote:So given the above, it would be prudent to "rebalance" yearly or such, to match the evolving allocation to "ones age in bonds", and correct me here, retain that AA if one would annuitize some of those assets via SPIA, or laddered SPIA over time.
Is this true?
livesoft wrote:The best way to rebalance will be a combination of every possible way and will depend on the circumstances and your tax situation.
. . . . . . . .
Bottom line: Don't get trapped into thinking that there is one single best method to rebalance and don't get trapped into thinking that one can only use one method of rebalancing. However, don't pay transactions fees nor taxes nor any other costs to rebalance because it is so easy to avoid all those things. Just inject some common sense (instead of conventional wisdom) into your decisions.
Thanks "lifesoft". Good stuff. Will do.
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Re: Is rebalancing bunk?

Post by willthrill81 » Sun Jan 29, 2017 3:19 pm

Dottie57 wrote:
plannerman wrote:I rebalance primarily to control risk. Which means, in "normal" times, selling equities and buying fixed income. However, those of us who rebalanced from fixed income into equities in 2008 and 2009, which by-the-way was one of the more difficult things I have done in a lifetime of investing, reaped a huge "rebalancing bonus" vis-a-vis buy and hold.

plannerman
Rebalancing also enforces to some degree, Buy low, sell high.
That's precisely why I rebalance. It 'forces' you to buy asset classes when they are low and sell them when they are high.
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Re: Is rebalancing bunk?

Post by Kevin M » Sun Jan 29, 2017 3:57 pm

nisiprius wrote: In fact, if our rebalancing rule triggers fairly often, it will look more like this. Now, to determine overall gain or loss we need to look at completely round-trip transactions, buy then sell. We can pair them up any way we like. Here, I've chosen to pair each purchase with the closest corresponding sale. Again, I'm just drawing this by hand, so I could be deceiving myself or you, just in a complicated way, and someday I hope to get around to doing some actual computer simulations, but this is the idea:

Image
It's actually easy to use Portfolio Visualizer (PV) to compare the difference between rebalancing using 5/25 bands (checking monthly) and not rebalancing, but PV doesn't make it obvious when the rebalancing events occur. A while back I built a spreadsheet to determine when the rebalancing events would occur using the data from PV. In the check I did I used a 60/40 portfolio of total US stocks (VTSMX) and intermediate-term Treasuries (VFITX) for the longest period available, starting in May 1992.

So the backtest is starting with a 60/40 portfolio of VTSMX/VFITX on the last day of April 1992, checking the allocations on the last day of each month, and rebalancing back to 60/40 if VTSMX is >= 65% or <= 55% of the portfolio. Note that this doesn't assume we start at 60/40 at the peak before the 2007-2009 decline, but that this policy had been in place since May 1992. With this test, the portfolio was at 59.23/40.77 at the end of October 2007, the peak before the 2007-2009 decline, so not that far off from 60/40 at this point.

Under these conditions, here are the rebalancing events between October 2007, the peak before the decline began, through September 2010, when the portfolio had fully recovered (showing the month the rebalancing occurred at the end of):

Jan 2008: VFITX -> VTSMX
Oct 2008: VFITX -> VTSMX
Jan 2009: VFITX -> VTSMX
Aug 2009: VTSMX -> VFITX

So three rebalancing events from bonds to stocks on the way down, and one from stocks to bonds on the way up for the full cycle.

Rather than pairing the rebalancing events to measure any rebalancing bonus, I'll simply run the PV backtest with and without rebalancing. Note that this changes things slightly, since it assumes going into November 2007 at exactly 60/40. This requires running the test through October 2010, because starting at 60/40 in November 2007, the portfolio was just shy of full recovery at the end of September 2010. Incidentally, with this test, the only change to the rebalancing events shown above is that the first rebalance occurred at the end of Feb 2008 instead of at the end of Jan 2008.

With rebalancing, CAGR = 0.79%, SD = 13.54%, max drawdown = -29.54%: Backtest Portfolio Asset Allocation.

Without rebalancing, CAGR = 0.54%, SD = 11.21%, max drawdown = -24.90%: Backtest Portfolio Asset Allocation.

So although there was a very small rebalancing bonus of 25 basis points, the rebalanced portfolio actually was riskier from a standard deviation and max drawdown perspective. I guess this is because of adding to stocks as they were declining, which seems to be somewhat confirmed by the even worse performance of Vanguard's 60/40 (US stocks / US bonds) Balanced Index fund (VBINX), with a CAGR of -0.17%, SD = 14.26%, and max drawdown = -32.57%, due to even more frequent rebalancing: Backtest Portfolio Asset Allocation.

Another observation is that for this period, in which stocks went down A LOT, simple annual rebalancing did better than 5/25 band rebalancing, and interestingly, also had slightly better return than no rebalancing. The key is that rebalancing at the beginning of January 2009 happened to occur close to the bottom for stocks, and skipped the intermediate rebalancing on the way down in October 2008. For the annually rebalanced portfolio during this period, CAGR = +1.54%, SD = 13.08%, and max drawdown = -27.90%, so better return but somewhat higher risk metrics than for no rebalancing. Backtest Portfolio Asset Allocation.

It seems to me that there are a couple of lessons here for those who argue that it's better to use Treasuries for the potential flight-to-safety rebalancing bonus in preference to CDs with higher yields for same maturities.

Lesson 1: The rebalancing bonus was only 25 basis points (annualized) over the full cycle for the worst flight-to-safety period we've seen in most of our lifetimes. This pales in comparison to the yield premium of good CDs over Treasuries of same maturity, which for me has been greater than 100 basis points over the last 6+ years.

Lesson 2: Using 5/25 bands to rebalance between US stocks and US Treasuries did worse than lazy annual rebalancing in terms of both return and risk metrics. So simply doing annual rebalancing with proceeds from maturing CDs in a CD ladder could have worked out even better than using Treasuries with 5/25 band rebalancing with monthly checking.

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Re: Is rebalancing bunk?

Post by Waba » Sun Jan 29, 2017 3:59 pm

nisiprius wrote:It seems obvious (?) that buying and holding for a very long period of time without rebalancing is going to result in a higher average stock allocation, and thus a higher dispersion of outcomes (risk) to go along with higher return.
...
Incidentally, reasonable assumptions lead consistently to the idea that, if the goal is keeping a stable level of portfolio risk, you only need to rebalance every three-to-five years or so.

I think rebalancing could get oversold because, as a slightly burdensome chore, it represents is a visible service an advisor can perform, thus justifying fees.
+1

Even for the advisor-less investor, it is rather hard to "just stand there", so maybe there is a psychological benefit to a yearly rebalancing ritual too.

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Re: Is rebalancing bunk?

Post by galeno » Sun Jan 29, 2017 4:08 pm

We use lazy annual rebalancing. Our SWR = 2.8%. Our port's net yield = 2.0%. We prune our 4 ETFs for the remaining 0.8% of annual living expenses.

Then and only then we look at rebalancing. If after pruning there is no 5/25 difference. No rebalancing occurs.

We wind up rebalancing once every three years or so. Most of the time we are pruning equities.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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Re: Is rebalancing bunk?

Post by Portfolio7 » Sun Jan 29, 2017 4:25 pm

Because I tweak my portfolio for attempted risk/reward optimization at least one per year, rebalancing is a moot point for me. I'm always near my risk target. A three fund portfolio would solve that problem, but create regret issues for me.

Maybe I'm finally at the point of good enough. However, 'know thyself' said the bard, so I don't pretend to be capable of behavior that my history contradicts.

I take comfort from the Vanguard study that seems to show variation in method and timing intervals make little difference in portfolio return.

Regardless, I believe maintaining my risk profile is crucial, no matter how I do it.
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Re: Is rebalancing bunk?

Post by CULater » Sun Jan 29, 2017 4:44 pm

So although there was a very small rebalancing bonus of 25 basis points, the rebalanced portfolio actually was riskier from a standard deviation and max drawdown perspective. I guess this is because of adding to stocks as they were declining,
I would say so. Stocks don't have consistent risk. There are periods of higher volatility; mostly when they are going down. A rebalancer has chosen to be a contrarian and time the purchase of more stocks just when the market has decided to reprice them and they have become more risky. He thinks he's smarter than the guy on the other side of the trade. Sometimes the gamble pays off, and sometimes it doesn't.
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Re: Is rebalancing bunk?

Post by nedsaid » Sun Jan 29, 2017 5:00 pm

It is important to know why you are rebalancing in the first place. I rebalance for risk control. Since stocks tend to outperform bonds, a portfolio that is not rebalanced will tend to become more stock heavy over time. This would result in a portfolio becoming more volatile or time and in the view of some, more risky.

Others believe there is a rebalancing bonus. My view is that sometimes you get a bonus and sometimes you don't. You have a better chance achieving the bonus when rebalancing between volatile asset classes rather than a stock/bond rebalancing. I am thinking of rebalancing between US Stocks and International Stocks, Stocks and REITs, Developed Markets and Emerging Markets, stuff like that.
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Re: Is rebalancing bunk?

Post by CULater » Sun Jan 29, 2017 5:09 pm

nedsaid wrote:It is important to know why you are rebalancing in the first place. I rebalance for risk control. Since stocks tend to outperform bonds, a portfolio that is not rebalanced will tend to become more stock heavy over time. This would result in a portfolio becoming more volatile or time and in the view of some, more risky.

Others believe there is a rebalancing bonus. My view is that sometimes you get a bonus and sometimes you don't. You have a better chance achieving the bonus when rebalancing between volatile asset classes rather than a stock/bond rebalancing. I am thinking of rebalancing between US Stocks and International Stocks, Stocks and REITs, Developed Markets and Emerging Markets, stuff like that.
Of course, you can take care of that side of things by just selling down stocks when they've become too overweighted. But buying more stocks when they've become underweighted has a whole different rationale, yes?
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Re: Is rebalancing bunk?

Post by CULater » Sun Jan 29, 2017 5:23 pm

From the man himself:
We also did an earlier study of all 25-year periods beginning in 1826 (!), using a 50/50 US stock/bond portfolio, and found that annual rebalancing won in 52% of the 179 periods. Also, it seems to me, noise. Interestingly, failing to rebalance never cost more than about 50 basis points, but when that failure added return, the gains were often in the 200-300 basis point range; i.e., doing nothing has lost small but it has won big. (I’m asking my good right arm, Kevin, to send the detailed data to you.)

My personal conclusion. Rebalancing is a personal choice, not a choice that statistics can validate. There’s certainly nothing the matter with doing it (although I don’t do it myself), but also no reason to slavishly worry about small changes in the equity ratio. Maybe, for example, if your 50% equity position grew to, say, 55% or 60%.
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