What is the main purpose of rebalancing?

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flyingaway
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What is the main purpose of rebalancing?

Post by flyingaway » Mon Sep 18, 2017 9:41 am

All main U.S. stock indexes are reaching historic new highs, and bond indexes are dropping. It seems to be a good time to rebalance. However, it is painful to sell the winners and buy the losers. So what is the main purpose of rebalancing? Is it preserving the stability of a portfolio, or increasing the amount of dry powder for the possible downturn?

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Re: What is the main purpose of rebalancing?

Post by oldcomputerguy » Mon Sep 18, 2017 9:45 am

flyingaway wrote:
Mon Sep 18, 2017 9:41 am
All main U.S. stock indexes are reaching historic new highs, and bond indexes are dropping. It seems to be a good time to rebalance. However, it is painful to sell the winners and buy the losers. So what is the main purpose of rebalancing? Is it preserving the stability of a portfolio, or increasing the amount of dry powder for the possible downturn?
You're right. It seems counter-intuitive to sell what has been climbing and buy what has been falling. But you have to look past that.

When you set up your portfolio, you chose an asset allocation based on your willingness, ability, and need to take risk. Your asset allocation is the main control of the amount of risk you're taking. If it drifts out, you might be taking more risk than you want (or less than you need to reach your goal). Rebalancing returns your portfolio to your chosen level of risk.

As a side benefit, selling your outperformers and buying underperformers is the definition of "buy low / sell high", the formula for making money in the market. :wink:
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Re: What is the main purpose of rebalancing?

Post by dbr » Mon Sep 18, 2017 9:49 am

flyingaway wrote:
Mon Sep 18, 2017 9:41 am
All main U.S. stock indexes are reaching historic new highs, and bond indexes are dropping. It seems to be a good time to rebalance. However, it is painful to sell the winners and buy the losers. So what is the main purpose of rebalancing? Is it preserving the stability of a portfolio, or increasing the amount of dry powder for the possible downturn?
The primary purpose of rebalancing is to keep the risk of the portfolio within an intended range. That is in the context of defining risk as the volatility of the portfolio which is determined by the ration of stocks to bonds. The primary end point one wants to avoid is that a portfolio left alone over a long time will eventually drift to a high and risky stock allocation because stocks return more than bonds. Consequently it makes sense to sell off stocks when they become too large a proportion. At the same time one does not want the portfolio to drift to too low an allocation to stocks as this will reduce the potential for return. As an example, many people would find themselves today in a position to rebalance. The signal for that is not "new highs" but how far your portfolio may be from your intended asset allocation.

The whole thing is based on the idea that one should design a portfolio for the trade-off of risk and return that best serves one's objectives and stay the course by keeping it there.

I am very strongly of the opinion that there is no more to it than that, as clever as different people might try to be. Also, "dry powder" is a useless metaphor that has no place in investing.

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Re: What is the main purpose of rebalancing?

Post by dbr » Mon Sep 18, 2017 9:52 am

oldcomputerguy wrote:
Mon Sep 18, 2017 9:45 am


As a side benefit, selling your outperformers and buying underperformers is the definition of "buy low / sell high", the formula for making money in the market. :wink:
It takes a lot of proving to show that rebalancing actually does any such thing. The actual effect of rebalancing in the long term is to suppress returns by preventing the portfolio from drifting to higher allocations of higher risk investments. This is desired because your first, and excellently stated, reason is fundamental to good investing.

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Re: What is the main purpose of rebalancing?

Post by lack_ey » Mon Sep 18, 2017 9:53 am

It is portfolio maintenance, bringing your allocation closer to what you actually intend, after market forces have caused it to drift out of alignment.

As such it can be, or is usually thought of as a form of risk management. In the usual formulation, bringing allocations back to fixed percentages, this may not be perfectly correct or most effective in a sense because the total amount of assets you have has a bearing on the amount of risk you can take, and the forward-looking risk of assets ex-ante varies over time. But at least it instills some discipline and may be plenty good enough.

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Re: What is the main purpose of rebalancing?

Post by Jack FFR1846 » Mon Sep 18, 2017 9:57 am

I look at it as assuming that equities follow a sin(x)+slope function, where slope is economic growth long term. Bonds follow sin(x_180 degrees)+slope. Theoretically, both stocks and bonds are going to grow but they diverge as they move along. Rebalancing is taking advantage of these waves.

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avalpert
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Re: What is the main purpose of rebalancing?

Post by avalpert » Mon Sep 18, 2017 10:06 am

flyingaway wrote:
Mon Sep 18, 2017 9:41 am
All main U.S. stock indexes are reaching historic new highs, and bond indexes are dropping. It seems to be a good time to rebalance. However, it is painful to sell the winners and buy the losers. So what is the main purpose of rebalancing? Is it preserving the stability of a portfolio, or increasing the amount of dry powder for the possible downturn?
Others have covered your initial question well so what I want to do is challenge your premise - what makes you think bond indexes are dropping? From my quick look seems to show they have been climbing steadily and are at or near all-time highs as well (as you would expect from appreciating assets a good percentage of the time). For the most part, when you rebalance between stocks and bonds (or asset classes within stocks and bonds) you are selling and buying assets that have been going up, they just go up at different paces.

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Re: What is the main purpose of rebalancing?

Post by Grt2bOutdoors » Mon Sep 18, 2017 10:09 am

flyingaway wrote:
Mon Sep 18, 2017 9:41 am
All main U.S. stock indexes are reaching historic new highs, and bond indexes are dropping. It seems to be a good time to rebalance. However, it is painful to sell the winners and buy the losers. So what is the main purpose of rebalancing? Is it preserving the stability of a portfolio, or increasing the amount of dry powder for the possible downturn?
What happens when the winners become losers? Woulda, coulda, shoulda......don't let that happen to you. It's more painful to watch your winners become losers, you hold on thinking it will rebound only to watch them set new lows each day. Don't let that happen to you. You rebalance to ensure your account remains within the parameters you established with your Investment Policy Statement. You do have an IPS, don't you?
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aristotelian
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Re: What is the main purpose of rebalancing?

Post by aristotelian » Mon Sep 18, 2017 10:22 am

Why did you buy bonds in the first place? Whatever the reason was, that is the reason for rebalancing now.

livesoft
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Re: What is the main purpose of rebalancing?

Post by livesoft » Mon Sep 18, 2017 10:25 am

Another purpose of rebalancing is to give you the chance to think about your portfolio, your asset allocation, your IPS, and have some fun making decisions and implementing transactions. Basically: It takes the boredom out of investing.
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Re: What is the main purpose of rebalancing?

Post by NYCPete » Mon Sep 18, 2017 10:43 am

flyingaway wrote:
Mon Sep 18, 2017 9:41 am
All main U.S. stock indexes are reaching historic new highs, and bond indexes are dropping. It seems to be a good time to rebalance. However, it is painful to sell the winners and buy the losers. So what is the main purpose of rebalancing? Is it preserving the stability of a portfolio, or increasing the amount of dry powder for the possible downturn?
Dbr's response explaining rebalancing is excellent.

Another thought worth remembering: when you strip out all the asset allocation, modern portfolio theory, costs, indexing, and everything else, you can boil investing down to its core. Buying something, having it go up in value, and selling it for more than you bought it. Or, in other words, buy low/sell high.

When you say you don't want to sell the winners and buy the losers, are you saying you don't believe that buying low and selling high is going to make you money? Would you rather buy high and sell low???

Seriously, take a step back and think about what you're saying.

Best,
Peter
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livesoft
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Re: What is the main purpose of rebalancing?

Post by livesoft » Mon Sep 18, 2017 11:00 am

I think one simply has to accept the fact that one might not sell high enough nor buy low enough when one is rebalancing.

If you haven't read this thread where folks tell us the amount of rebalancing that they do (as opposed to theory), then check it out:
viewtopic.php?f=1&t=227582
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Re: What is the main purpose of rebalancing?

Post by The Wizard » Mon Sep 18, 2017 11:25 am

As some others have mentioned, rebalancing can be thought of as taking incremental profits or doing the buy low/sell high thing.
That frame of mind makes it easier to do.

But yes, it's controlling risk as well...
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Re: What is the main purpose of rebalancing?

Post by bottlecap » Mon Sep 18, 2017 11:36 am

To reduce risk/volatility. "Dry powder" is an over-used analogy, not a purpose in and of itself.

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Re: What is the main purpose of rebalancing?

Post by dbr » Mon Sep 18, 2017 11:43 am

Those who continue to promote the buy low/sell high concept should probably research the subject to see if rebalancing actually accomplishes this end and is a management process to significantly increase return without taking additional risk. I would leave it as an exercise for the forum to determine what the outcome is.

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Re: What is the main purpose of rebalancing?

Post by jebmke » Mon Sep 18, 2017 11:47 am

dbr wrote:
Mon Sep 18, 2017 11:43 am
Those who continue to promote the buy low/sell high concept should probably research the subject to see if rebalancing actually accomplishes this end and is a management process to significantly increase return without taking additional risk. I would leave it as an exercise for the forum to determine what the outcome is.
Certainly there are situations that would not. I retired in December 2007. Part of my retirement was a windfall from exercising NQ options. Once the cash hit my account I was over allocated in fixed income and bought equity to restore the percentage. I bought high and later TLH/re-balanced to buy more after the market tanked.
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Re: What is the main purpose of rebalancing?

Post by JoMoney » Mon Sep 18, 2017 11:54 am

dbr wrote:
Mon Sep 18, 2017 11:43 am
Those who continue to promote the buy low/sell high concept should probably research the subject to see if rebalancing actually accomplishes this end and is a management process to significantly increase return without taking additional risk. I would leave it as an exercise for the forum to determine what the outcome is.
What I've found playing with data myself is period dependent, which makes for good forum fodder allowing people to argue either way.
I'll add, that what I've found is the same as Mr.Bogle said in this old Blog post in his question/response to RJM/Mr.M :
http://johncbogle.com/wordpress/2007/06 ... estions-2/
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Re: What is the main purpose of rebalancing?

Post by farnsy » Mon Sep 18, 2017 11:57 am

Most Bogleheads portfolios are, or should be, close to market capitalization weights. If that is the case, then there is not a lot of rebalancing to be done. When one stock goes up in price, it also goes up in market capitalization by the same proportion, so there is no trading necessary to get to the original weights.

The only "rebalancing" necessary for a market-cap weighted portfolio is reinvesting dividends. It is this fact that allows index funds to have extremely low turnover--their portfolios are nearly market-cap weighted and therefore require little trading.

Of course, on an asset-class level many of us do deviate from market capitalization, so there is some movement of money from one asset class to another, but this doesn't involve nearly the amount of trading as rebalancing on an individual asset basis. Also, the same logic that requires that we *not* rebalance on an individual asset basis suggests that we shouldn't do a lot of rebalancing on an asset-class basis.

I don't rebalance unless my portfolio gets very far from my intended weights. When I do rebalance, I generally do so only by adding new money to the "underweighted" allocations. I virtually never sell and I don't think most people should during the saving period of their lives.

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Re: What is the main purpose of rebalancing?

Post by oldcomputerguy » Mon Sep 18, 2017 12:03 pm

dbr wrote:
Mon Sep 18, 2017 9:52 am
oldcomputerguy wrote:
Mon Sep 18, 2017 9:45 am


As a side benefit, selling your outperformers and buying underperformers is the definition of "buy low / sell high", the formula for making money in the market. :wink:
It takes a lot of proving to show that rebalancing actually does any such thing. The actual effect of rebalancing in the long term is to suppress returns by preventing the portfolio from drifting to higher allocations of higher risk investments. This is desired because your first, and excellently stated, reason is fundamental to good investing.
I didn't intend to imply that rebalancing improved returns in any signficant way versus non-rebalancing. I was putting forth the "buy-low-sell-high" paradigm as a (perhaps tongue-in-cheek) way to counteract one's reluctance to sell what has been outperforming and buy what hasn't.
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Re: What is the main purpose of rebalancing?

Post by avalpert » Mon Sep 18, 2017 12:10 pm

oldcomputerguy wrote:
Mon Sep 18, 2017 12:03 pm
dbr wrote:
Mon Sep 18, 2017 9:52 am
oldcomputerguy wrote:
Mon Sep 18, 2017 9:45 am


As a side benefit, selling your outperformers and buying underperformers is the definition of "buy low / sell high", the formula for making money in the market. :wink:
It takes a lot of proving to show that rebalancing actually does any such thing. The actual effect of rebalancing in the long term is to suppress returns by preventing the portfolio from drifting to higher allocations of higher risk investments. This is desired because your first, and excellently stated, reason is fundamental to good investing.
I didn't intend to imply that rebalancing improved returns in any signficant way versus non-rebalancing. I was putting forth the "buy-low-sell-high" paradigm as a (perhaps tongue-in-cheek) way to counteract one's reluctance to sell what has been outperforming and buy what hasn't.
The problem with that is when rebalancing between assets with significantly different expected returns (like stocks and bonds) you shouldn't expect to be buying low and selling high. If you set that up as your expectation then see your stock fund continue to outpace your bond fund (as it will most of the time) after you sold out of it I think you ultimately will be less likely to keep up with rebalancing then if you approached it honestly from the start.

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Re: What is the main purpose of rebalancing?

Post by NYCPete » Mon Sep 18, 2017 12:28 pm

oldcomputerguy wrote:
Mon Sep 18, 2017 12:03 pm
dbr wrote:
Mon Sep 18, 2017 9:52 am
oldcomputerguy wrote:
Mon Sep 18, 2017 9:45 am


As a side benefit, selling your outperformers and buying underperformers is the definition of "buy low / sell high", the formula for making money in the market. :wink:
It takes a lot of proving to show that rebalancing actually does any such thing. The actual effect of rebalancing in the long term is to suppress returns by preventing the portfolio from drifting to higher allocations of higher risk investments. This is desired because your first, and excellently stated, reason is fundamental to good investing.
I didn't intend to imply that rebalancing improved returns in any signficant way versus non-rebalancing. I was putting forth the "buy-low-sell-high" paradigm as a (perhaps tongue-in-cheek) way to counteract one's reluctance to sell what has been outperforming and buy what hasn't.
Re: the buy low sell high cliche, if only every dilemma were easily solved by exactly following the empirical analysis and what the data shows, we'd all be better off. But the emotional side of investing, and the parts of our brain that make us want to do sub-optimal things are not always going to be persuaded by the data. Whether rebalancing actually results in a true buy low sell high result is missing the point. When a person says that a certain act they know they should be doing is "painful," it's an indication that emotions are playing into a decision. Not adherence to what logic and the data show.

To add to what oldcomputerguy said, the "buy low sell high" talking point could be thought of as an emotional shortcut to do what we know we ought to be doing.

That said, I'm somewhat surprised this is coming off as even somewhat controversial. I remember reading this adage in relation to re-balancing in more than one book on the Bogleheads reading list over the years.
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avalpert
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Re: What is the main purpose of rebalancing?

Post by avalpert » Mon Sep 18, 2017 12:38 pm

NYCPete wrote:
Mon Sep 18, 2017 12:28 pm
oldcomputerguy wrote:
Mon Sep 18, 2017 12:03 pm
dbr wrote:
Mon Sep 18, 2017 9:52 am
oldcomputerguy wrote:
Mon Sep 18, 2017 9:45 am


As a side benefit, selling your outperformers and buying underperformers is the definition of "buy low / sell high", the formula for making money in the market. :wink:
It takes a lot of proving to show that rebalancing actually does any such thing. The actual effect of rebalancing in the long term is to suppress returns by preventing the portfolio from drifting to higher allocations of higher risk investments. This is desired because your first, and excellently stated, reason is fundamental to good investing.
I didn't intend to imply that rebalancing improved returns in any signficant way versus non-rebalancing. I was putting forth the "buy-low-sell-high" paradigm as a (perhaps tongue-in-cheek) way to counteract one's reluctance to sell what has been outperforming and buy what hasn't.
Re: the buy low sell high cliche, if only every dilemma were easily solved by exactly following the empirical analysis and what the data shows, we'd all be better off. But the emotional side of investing, and the parts of our brain that make us want to do sub-optimal things are not always going to be persuaded by the data. Whether rebalancing actually results in a true buy low sell high result is missing the point. When a person says that a certain act they know they should be doing is "painful," it's an indication that emotions are playing into a decision. Not adherence to what logic and the data show.

To add to what oldcomputerguy said, the "buy low sell high" talking point could be thought of as an emotional shortcut to do what we know we ought to be doing.

That said, I'm somewhat surprised this is coming off as even somewhat controversial. I remember reading this adage in relation to re-balancing in more than one book on the Bogleheads reading list over the years.
I am all for emotional shortcuts to trick you brain to act as if it were actually a rational entity - I just don't think this is a good one. I think this is the kind of mental trick that ends up biting you - the one that has you jumping to Plan B near the bottom of the downturn as you get tired of seeing your attempts to 'buy low' going lower or to take on increasing risk near the top of the upswing as you give up on seeing your attempts to 'sell high' keep going up.

There are better tricks out there, like using funds that do the rebalancing for you or rebalancing only with new money (during accumulation at least - during the withdrawal phase you reverse it by rebalancing only through withdrawals).

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Re: What is the main purpose of rebalancing?

Post by oldcomputerguy » Mon Sep 18, 2017 2:12 pm

NYCPete wrote:
Mon Sep 18, 2017 12:28 pm
That said, I'm somewhat surprised this is coming off as even somewhat controversial. I remember reading this adage in relation to re-balancing in more than one book on the Bogleheads reading list over the years.
Indeed, it's discussed in "The Bogleheads' Guide to Investing" (in the section "Why Rebalance?", pages 200-201):
Rebalancing forces us to sell high and buy low. We're selling the outperforming asset class or segment and buying the underperforming asset class or segment That's exactly what smart investors want to do.

[...]

Often, investors who don't rebalance are simply letting their winners run in the belief that doing so would produce much higher returns. Contrary to what those investors might believe, the article reported that the increased returns were actually found to be small or even nonexistent when compared with the additional risk (as measured by the volatility) taken on by those investors who didn't rebalance.

[...]

Rebalancing may also improve your returns, since asset classes have had a tendency to revert to the mean (RTM) over time. By rebalancing, yoiu're selling a portion of your winning asset classes before they revert to the mean (drop in price) and you're buying more of your underperforming asset classes when their prices are lower, before they revert to the mean (increase in value). So, you're selling high and buying low. If you believe in RTM, rebalancing could increase your returns. Jack Bogle believes in RTM, and we do, too.
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Re: What is the main purpose of rebalancing?

Post by livesoft » Mon Sep 18, 2017 2:29 pm

I'll write this: If you are not making money from rebalancing, then you are probably not doing it in a way that is available to you and can make you money.

It is kinda like market timing. The news about market timing is that it cannot be done successfully and that it always fails. The reality is somewhat different: It cannot be done successfully 100% of the time, but it doesn't always fail.

We don't expect stocks to go up all the time monotonically, so we shouldn't expect rebalancing nor market timing to increase the value of our portfolios all the time either.
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Re: What is the main purpose of rebalancing?

Post by garlandwhizzer » Mon Sep 18, 2017 5:53 pm

I believe the main purpose is to reduce risk. It provides a formula for making asset allocation changes which, if followed, may reduce emotion-based buy/sell decisions. To be successful however, a high level of self-knowledge, especially risk tolerance, is necessary. Often it takes the real experience of a few nasty bear markets to discover that.

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Re: What is the main purpose of rebalancing?

Post by flyingaway » Mon Sep 18, 2017 8:15 pm

So rebalancing is buy but not hold?

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Re: What is the main purpose of rebalancing?

Post by FIREchief » Mon Sep 18, 2017 11:45 pm

I used to think I knew the answer(s) to this question, but thanks largely to this forum I learned that the answers are not a crisp as I originally thought. I also learned about the LMP/RP approach to asset allocations, which is what I now embrace. With this strategy, I never rebalance.
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Re: What is the main purpose of rebalancing?

Post by GoldenFinch » Tue Sep 19, 2017 6:06 am

FIREchief wrote:
Mon Sep 18, 2017 11:45 pm
I used to think I knew the answer(s) to this question, but thanks largely to this forum I learned that the answers are not a crisp as I originally thought. I also learned about the LMP/RP approach to asset allocations, which is what I now embrace. With this strategy, I never rebalance.
What is LMP/RP?

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Re: What is the main purpose of rebalancing?

Post by bottlecap » Tue Sep 19, 2017 6:31 am

flyingaway wrote:
Mon Sep 18, 2017 8:15 pm
So rebalancing is buy but not hold?
"Buy and hold" is a catchphrase. If it is important to you, consider this: you are "buying and holding" a specific allocation. Selling one part of that allocation to buy another part is not "selling and not holding." You remain in the market.

Dont think buy and hold means never selling. If you don't sell at some point, you're either not rebalancing, you died too early, or both.

JT

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Re: What is the main purpose of rebalancing?

Post by Grt2bOutdoors » Tue Sep 19, 2017 7:01 am

GoldenFinch wrote:
Tue Sep 19, 2017 6:06 am
FIREchief wrote:
Mon Sep 18, 2017 11:45 pm
I used to think I knew the answer(s) to this question, but thanks largely to this forum I learned that the answers are not a crisp as I originally thought. I also learned about the LMP/RP approach to asset allocations, which is what I now embrace. With this strategy, I never rebalance.
What is LMP/RP?
Liability Matching Portfolio - generally meant to hold a safe basket of fixed income vehicles such as TIPs, I bonds, short term fixed, Social Security, pensions that will meet your known and expected level of annual expenses for X years or span of retirement

Risk Portfolio - a basket of risky assets such as equities, where future value is unknown but permits you to share in future gains/losses of the markets. You aren't relying on your risk portfolio to meet your liabilities, that is what the LMP is designed to do.
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Re: What is the main purpose of rebalancing?

Post by JPH » Tue Sep 19, 2017 7:43 am

For me the only reason to rebalance is to manage risk. Never bear too much or too little risk.
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Re: What is the main purpose of rebalancing?

Post by flyingaway » Tue Sep 19, 2017 7:53 am

JPH wrote:
Tue Sep 19, 2017 7:43 am
For me the only reason to rebalance is to manage risk. Never bear too much or too little risk.
The level of risk is proportional to the portion of stocks in your portfolio. I think for many people, it is not easy to say whether 80/20, 70/30, or 60/40 is the best for a particular person. They probably will know the right combination after a downturn, but not before.

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Re: What is the main purpose of rebalancing?

Post by JPH » Tue Sep 19, 2017 8:18 am

flyingaway wrote:
Tue Sep 19, 2017 7:53 am
JPH wrote:
Tue Sep 19, 2017 7:43 am
For me the only reason to rebalance is to manage risk. Never bear too much or too little risk.
The level of risk is proportional to the portion of stocks in your portfolio. I think for many people, it is not easy to say whether 80/20, 70/30, or 60/40 is the best for a particular person. They probably will know the right combination after a downturn, but not before.
I agree. It is not always easy to pinpoint the degree of risk that you want, and a few experiences with market downturns can help one set the desired AA. But decide everyone must.
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Re: What is the main purpose of rebalancing?

Post by rbaldini » Tue Sep 19, 2017 8:40 am

You decided at some point that your preferred stock/bond allocation is X/Y. You decided this was the best risk/reward tradeoff for you.

Market forces have moved your actual allocation to (X+d)/(Y-d). You are now taking on either too much risk or gaining too little reward.

The purpose of rebalancing is to move your allocation back to X/Y, your preferred value. That's it. If you didn't rebalance, you'd have no way of controlling your asset allocation, and therefore no way of controlling your risk/reward tradeoff.

flyingaway
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Re: What is the main purpose of rebalancing?

Post by flyingaway » Tue Sep 19, 2017 8:52 am

JPH wrote:
Tue Sep 19, 2017 8:18 am
flyingaway wrote:
Tue Sep 19, 2017 7:53 am
JPH wrote:
Tue Sep 19, 2017 7:43 am
For me the only reason to rebalance is to manage risk. Never bear too much or too little risk.
The level of risk is proportional to the portion of stocks in your portfolio. I think for many people, it is not easy to say whether 80/20, 70/30, or 60/40 is the best for a particular person. They probably will know the right combination after a downturn, but not before.
I agree. It is not always easy to pinpoint the degree of risk that you want, and a few experiences with market downturns can help one set the desired AA. But decide everyone must.
I would like to know my level of risk tolerance well before the crash comes. During 2000 and 2008, I did not do anything, not because I was smart, but because I did not have much and did not pay attention to investing (spending all time on my work to make money). But things have changed. I now have achieved financial independence and I am much less interested in making money from my work.

Valuethinker
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Re: What is the main purpose of rebalancing?

Post by Valuethinker » Tue Sep 19, 2017 8:57 am

flyingaway wrote:
Mon Sep 18, 2017 9:41 am
All main U.S. stock indexes are reaching historic new highs, and bond indexes are dropping. It seems to be a good time to rebalance. However, it is painful to sell the winners and buy the losers. So what is the main purpose of rebalancing? Is it preserving the stability of a portfolio, or increasing the amount of dry powder for the possible downturn?
For a given risk-return level, if you do not rebalance, you have "drift". Your risk creeps up (if stocks have been outperforming) or down (if they have underperformed bonds).

As a result, you don't have your strategy any more. You have a new risk-return profile.

A secondary advantage is that if stocks mean revert (and there is some evidence that they do, i.e. periods of strong performance are followed by weak, and vice versa) then you are exploiting that by selling the outperforming asset (which will eventually underperform) and by buying the underperforming one.

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welderwannabe
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Re: What is the main purpose of rebalancing?

Post by welderwannabe » Tue Sep 19, 2017 9:00 am

I love nothing more than rebalancing into bonds. It makes me feel good to take a profit and move it somewhere more safe. My emotions get in the way of the reverse...when stocks are down and I need to rebalance from bonds into stocks. That is where I have a hard time pulling the trigger.

All of our emotions affect us all in different ways. As much as it is easy to say the Boglehead way is to act like a robot, none of us are robots.
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

flyingaway
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Re: What is the main purpose of rebalancing?

Post by flyingaway » Tue Sep 19, 2017 9:05 am

welderwannabe wrote:
Tue Sep 19, 2017 9:00 am
I love nothing more than rebalancing into bonds. It makes me feel good to take a profit and move it somewhere more safe. My emotions get in the way of the reverse...when stocks are down and I need to rebalance from bonds into stocks. That is where I have a hard time pulling the trigger.

All of our emotions affect us all in different ways. As much as it is easy to say the Boglehead way is to act like a robot, none of us are robots.
Do you have a specific band to decide when to rebalance?

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welderwannabe
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Re: What is the main purpose of rebalancing?

Post by welderwannabe » Tue Sep 19, 2017 9:08 am

flyingaway wrote:
Tue Sep 19, 2017 9:05 am
Do you have a specific band to decide when to rebalance?
Anything more than 1% is fair game for me. The conventional wisdom says 5%, but that is too big of a swing for my emotions. I would never rebalance from bonds into stocks if I waited for a 5% delta! Little bites make it easier for me.
I am not an investment professional, but I did stay at a Holiday Inn Express last night.

JW-Retired
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Re: What is the main purpose of rebalancing?

Post by JW-Retired » Tue Sep 19, 2017 9:17 am

Grt2bOutdoors wrote:
Tue Sep 19, 2017 7:01 am
GoldenFinch wrote:
Tue Sep 19, 2017 6:06 am
FIREchief wrote:
Mon Sep 18, 2017 11:45 pm
I used to think I knew the answer(s) to this question, but thanks largely to this forum I learned that the answers are not a crisp as I originally thought. I also learned about the LMP/RP approach to asset allocations, which is what I now embrace. With this strategy, I never rebalance.
What is LMP/RP?
Liability Matching Portfolio - generally meant to hold a safe basket of fixed income vehicles such as TIPs, I bonds, short term fixed, Social Security, pensions that will meet your known and expected level of annual expenses for X years or span of retirement

Risk Portfolio - a basket of risky assets such as equities, where future value is unknown but permits you to share in future gains/losses of the markets. You aren't relying on your risk portfolio to meet your liabilities, that is what the LMP is designed to do.
Liability Matching Portfolio....... thank you FIREchief & Grt2bOutdoors! Didn't realize what DW & I more or less do had a name. Can't say we "never re-balance", but if/when we do it's only very slowly, and we don't ever sell our safe fixed income vehicles to re-balance.

LMP for us! :beer
JW
Retired at Last

ecotone
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Re: What is the main purpose of rebalancing?

Post by ecotone » Tue Sep 19, 2017 9:32 am

My 401(k) provider offers an automatic rebalancing feature (guessing many do...) and I appreciate this feature. It forces me to buy low and sell high once a year. Not the perfect process, but it keeps me (and my portfolio) honest.

lotusflower
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Re: What is the main purpose of rebalancing?

Post by lotusflower » Tue Sep 19, 2017 12:34 pm

It's been a while since I read it, but David Swensen's book https://www.amazon.com/Unconventional-S ... B000FCKBT8 lays out the method and the experience showing that rebalancing applies a continuous buy low/sell high to your portfolio. He admits that it works better if you are an institutional investor with ultra-low trade fees and different tax rules, but he still maintains that everyone should rebalance to cash out winners and buy that which is currently undervalued.

It's so easy to forget that high and low only have definitions in the world of past performance. If it were possible to predict highs and lows, that would always be better than what you can get from rebalancing but even Swensen admits that you can't predict them, and so rebalancing is superior to most other methods for long-term performance, according to the book.

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Re: What is the main purpose of rebalancing?

Post by Johnnie » Tue Sep 19, 2017 1:36 pm

dbr wrote:
Mon Sep 18, 2017 9:52 am
oldcomputerguy wrote:
Mon Sep 18, 2017 9:45 am


As a side benefit, selling your outperformers and buying underperformers is the definition of "buy low / sell high", the formula for making money in the market. :wink:
It takes a lot of proving to show that rebalancing actually does any such thing. The actual effect of rebalancing in the long term is to suppress returns by preventing the portfolio from drifting to higher allocations of higher risk investments. This is desired because your first, and excellently stated, reason is fundamental to good investing.
I asked this one time before and the answer was unsatisfactory: The stock market goes up two years out of three, and over the past 90 years or so the "random walk" has generally been in a not-so-random up-direction, barring some minor hiccups like 1929, 1937, 1973-74, 2000 and 2008. <ouch<

Yes yes, PPINGOFFR, but that seems to suggest that there is some "buy low sell high" involved.
"I know nothing."

thangngo
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Re: What is the main purpose of rebalancing?

Post by thangngo » Tue Sep 19, 2017 1:47 pm

flyingaway wrote:
Mon Sep 18, 2017 9:41 am
All main U.S. stock indexes are reaching historic new highs, and bond indexes are dropping. It seems to be a good time to rebalance. However, it is painful to sell the winners and buy the losers. So what is the main purpose of rebalancing? Is it preserving the stability of a portfolio, or increasing the amount of dry powder for the possible downturn?
You are looking at short-term benefit rather than long-term benefit.

It's buy low/sell high concept. If stock goes higher, you continue to sell stock and buy the lower (bond). There are periods where bond outperforms stock, you'll sell bond and lock-in the gain then.

avalpert
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Re: What is the main purpose of rebalancing?

Post by avalpert » Tue Sep 19, 2017 1:56 pm

Johnnie wrote:
Tue Sep 19, 2017 1:36 pm
The stock market goes up two years out of three, and over the past 90 years or so the "random walk" has generally been in a not-so-random up-direction,
That's not what a random walk means - random walks can have upward biases.

But yes, most rebalancing is selling an asset that has been going up to buy another asset that has been going up too.

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inittowinit
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Re: What is the main purpose of rebalancing?

Post by inittowinit » Tue Sep 19, 2017 2:09 pm

bottlecap wrote:
Mon Sep 18, 2017 11:36 am
"Dry powder" is an over-used analogy, not a purpose in and of itself.
dbr wrote:Also, "dry powder" is a useless metaphor that has no place in investing.
Well said

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bengal22
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Re: What is the main purpose of rebalancing?

Post by bengal22 » Tue Sep 19, 2017 2:30 pm

flyingaway wrote:
Mon Sep 18, 2017 9:41 am
All main U.S. stock indexes are reaching historic new highs, and bond indexes are dropping. It seems to be a good time to rebalance. However, it is painful to sell the winners and buy the losers. So what is the main purpose of rebalancing? Is it preserving the stability of a portfolio, or increasing the amount of dry powder for the possible downturn?
Rebalancing keeps you aligned with the asset allocation that you spent so much thought on determining.

flyingaway
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Re: What is the main purpose of rebalancing?

Post by flyingaway » Tue Sep 19, 2017 2:38 pm

lotusflower wrote:
Tue Sep 19, 2017 12:34 pm
It's been a while since I read it, but David Swensen's book https://www.amazon.com/Unconventional-S ... B000FCKBT8 lays out the method and the experience showing that rebalancing applies a continuous buy low/sell high to your portfolio. He admits that it works better if you are an institutional investor with ultra-low trade fees and different tax rules, but he still maintains that everyone should rebalance to cash out winners and buy that which is currently undervalued.

It's so easy to forget that high and low only have definitions in the world of past performance. If it were possible to predict highs and lows, that would always be better than what you can get from rebalancing but even Swensen admits that you can't predict them, and so rebalancing is superior to most other methods for long-term performance, according to the book.
If I were not careful, I would consider this as small scale market timing.

rbaldini
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Re: What is the main purpose of rebalancing?

Post by rbaldini » Tue Sep 19, 2017 2:50 pm

Note: If you believe the stock and bond markets are an independent random walk (with positive drift), then rebalancing is *not* a method for buying low and selling high. It is not a method for boosting risk-adjusted return. It is simply a way of maintaining your preferred asset allocation.

GoldenFinch
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Re: What is the main purpose of rebalancing?

Post by GoldenFinch » Tue Sep 19, 2017 4:24 pm

Grt2bOutdoors wrote:
Tue Sep 19, 2017 7:01 am
GoldenFinch wrote:
Tue Sep 19, 2017 6:06 am
FIREchief wrote:
Mon Sep 18, 2017 11:45 pm
I used to think I knew the answer(s) to this question, but thanks largely to this forum I learned that the answers are not a crisp as I originally thought. I also learned about the LMP/RP approach to asset allocations, which is what I now embrace. With this strategy, I never rebalance.
What is LMP/RP?
Liability Matching Portfolio - generally meant to hold a safe basket of fixed income vehicles such as TIPs, I bonds, short term fixed, Social Security, pensions that will meet your known and expected level of annual expenses for X years or span of retirement

Risk Portfolio - a basket of risky assets such as equities, where future value is unknown but permits you to share in future gains/losses of the markets. You aren't relying on your risk portfolio to meet your liabilities, that is what the LMP is designed to do.
Thanks :happy

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