Can you rebalance your way to $0?

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carol-brennan
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Can you rebalance your way to $0?

Post by carol-brennan » Fri Feb 08, 2019 6:48 am

Rebalancing presumes a reversion to the mean for the assets held, doesn't it?

What if one of those assets in a portfolio doesn't revert to the mean but stays low or declines for the duration of one's life. Yet one continues to rebalance into that declining asset with the "good money" portion of a portfolio?

How long can one go?

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Re: Can you rebalance your way to $0?

Post by nisiprius » Fri Feb 08, 2019 7:36 am

This is an odd example of something that is mathematically possible and no limit can be placed on it, yet basically irrelevant in any plausible real-life situation. (Some other examples are: how low can a bond fund go as a result of an interest rate increase, and "what would happen if literally everybody indexed?")

The math is clear enough. Say you rebalance every year at year-end, and your target allocation between assets "S" and "B" is 50/50. Assume you have $10,000 in each at the start of the year, and that their price per share is $100/share each, so you have 100 shares of each.

At the end of the year, suppose that the value of S drops to 0.01% of its starting value, so the two assets are worth $1 and $10,000. You wish to rebalance back to 50/50. The imbalance is $9,999, so you need to split the difference by liquidating half the the difference--$4,999.50--in B and buying more S, which gets you to $1 + $4999.50 = $5,000.50 in S, and $10,000 - $4999.50 = $5,000.50 in B.

Your total portfolio value has fallen from $20,000 to $10,001. It has fallen to about 50% of its original value, strictly 50.005%.

In extreme situations like this, rebalancing more frequently causes a larger loss. For example, if S drops to 1% of its starting value, you rebalance, it drops to 1% of its value again, and you rebalance again, S has overall dropped the same percentage as before--its value per share is 1% of 1% = 0.01%, but the results are different:

Start: $10,000, $10,000
First decline: $100, $10,000
First rebalance: $5,050, $5,050
Second decline: $50.50, $5,050
Second rebalance: $2,550, $2,550.

So instead of being 50% of its original value, your portfolio is 25% of its original value (actually 25.5%).

In the case of a 50/50 portfolio, every successive almost-total loss in S will, on the next rebalance, drop your portfolio value to about 50% of what it was before--cuts it in half every time.

Can it go to zero? The mathematician talks about the concept of a limit, and the easiest way to put this in non-mathematical terms is that it can't actually get to zero, but if you will tell me how low you want it to go, I will tell you how many decline-and-rebalance steps it will take to get there. I can tell you how to lose any desired of money as long as it's less than $20,000. You want to turn your $20,000 into a penny? Great, just let stocks lose almost all of their value, then rebalance, about 21 times. Let's say 22 times, to be safe.

In the real-life case where the value of S literally becomes zero, the math explodes (requires a division by zero), and in the real world you simply can't do it--if something has a value of zero, there is no way to buy $5,000 worth of it.

Now, the real world.

The best example I can give is one that was personally very relevant to me in 2008-2009, when the stock market plunged about 50%, while the bonds I was holding, mostly in the form of Vanguard Total Bond Market Index Fund), basically did not change. I was holding a big-to-me amount of the Vanguard Balanced Index Fund, which maintains a 60/40 allocation and rebalances almost continuously. I was trying to keep mental track of things, and if the stock market had dropped by, say, 20% from where it had been, I would say to myself "well, then, VBINX should have dropped by 60% of 20% = 12%." And every time I looked, it had dropped just a little bit more than that. It first I kept thinking it was sloppy mental math, but it was just enough more that eventually I dug in and looked harder. Nope, it was really happening, it was the effect you mention.

According to PortfolioVisualizer, the "max drawdown" for Total Stock was -50.84%, and for Balanced Index -32.45%. You might think that since Balanced Index is 60% Total Stock, the drawdown should have been -50.84% x 60% = -30.05%, but, no, it was -32.45%. You can do the calculation various ways--after all, Total Bond was up slightly, etc.--but every time I've done it, the result I get is that the number-of-dollar-loss in VBINX was about ten percent worse that it would have been without rebalancing.

Of course, I got it back when the stock market recovered. During the rise, the value of VBINX kept increasing by a percentage that was slightly higher than 60%-of-the-Total-Stock increase. And incidentally, when it recovered, there was virtually no difference between "rebalanced" versus "no rebalancing," so any expected "rebalancing bonus" did not materialize.

Since 2008-2009 represented a very bad case, and yet the effect was merely an irritating nuisance, this tells us that the theoretical issue isn't too important in practice.

I think people worry about this because they hate throwing good money after bad when they rebalance during a decline. I hate it myself, during 2008-2009 I basically did nothing. VBINX rebalanced for me, but in my other holdings, I did not rebalance. I didn't sell, good for me, but I couldn't bring myself to buy more, either. Well, it is what it is.
Last edited by nisiprius on Fri Feb 08, 2019 7:44 am, edited 3 times in total.
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Re: Can you rebalance your way to $0?

Post by livesoft » Fri Feb 08, 2019 7:37 am

The only way this can happen in my opinion is if the US economy goes to zero.

So that's the beauty of using index funds holding 3000+ different company stocks. Sure, some of them will go to zero, but not all of them.
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Re: Can you rebalance your way to $0?

Post by rkhusky » Fri Feb 08, 2019 8:02 am

And if it all goes to $0, then the US (and probably the rest of the world) has collapsed and you will need shelter, food, water, and weapons (and some physical gold wouldn't hurt). The stock market will be the last thing on your mind.

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Re: Can you rebalance your way to $0?

Post by nisiprius » Fri Feb 08, 2019 8:14 am

I'm not sure Carol-Brennan is seriously worried about rebalancing to $0. When this topic has come up before, it's usually been in the general context of "is rebalancing good or bad, necessary or optional, what exactly is it supposed to accomplish, can it actually manufacture extra return out of volatility, is it a formula for buying low and selling high."

When rebalancing isn't being over-promoted as a magical way to increase return, it is usually framed as a way to control risk by preventing your asset allocation from drifiting too far from your target. So then, the question becomes: does rebalancing actually reduce risk, or what?

In the case of a balanced fund that is frequently rebalanced... or a portfolio that is frequently rebalanced... then you have the interesting effect that over a long, sustained decline it actually increases risk as measured by "maximum drawdown." It does this throwing good money after bad on the way down, making the decline a little worse, but then it boosts returns on the way up, making the recovery a little better.

But the effect is small.

I'm convinced that rebalancing just isn't a big deal, and that its importance and its effect are exaggerated. My conspiracy theory is that advisors have a temptation to do this. They can frame it as a laborious chore that they can do for you, a valuable service they can point to that justifies their fee. It is in their interests to exaggerate its value, and to present it as something so complicated and arcane (don't just rebalance annually, use rebalancing bands, etc.) that you don't want to try it yourself.
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Re: Can you rebalance your way to $0?

Post by dbr » Fri Feb 08, 2019 9:30 am

nisiprius wrote:
Fri Feb 08, 2019 8:14 am

But the effect is small.
This is the crux of the issue. Aside from that, if a person sees a massive drawdown as a risk he very much wants to avoid he can decide not to rebalance into stocks (probably sensible only for retired people). That tactic is also equivalent in some general effect to having a lower allocation to stocks in the first place.

Then there is this thread: viewtopic.php?f=10&t=271975

PS When I say "decide" the best thing is that would be in the IPS from the get go. Deciding under fire at the moment is a less good idea.
Last edited by dbr on Fri Feb 08, 2019 10:28 am, edited 1 time in total.

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Re: Can you rebalance your way to $0?

Post by Dandy » Fri Feb 08, 2019 10:05 am

rebanancing is generally a good idea to keep portfolio risk near your educated guess at your risk tolerance. It is much easier in the accumulation stage since you likely have income that supports your needs and money left over for investment/rebalancing.

Retirement can change the dynamics a bit. You are now often faced with zero human capital, decades of funding to support your life style and a nest egg that must last up to 30 years or more. A prolonged equity decline would often require moving safer assets into equities as well as withdrawing safer assets to support current living expenses. It can lead to a legitimate test of your investment philosophy about rebalancing. At some point after a prolonged equity decline many retirees will likely stop or under rebalance to preserve what they consider a critical mass of nest egg assets. If they very much rely on their nest egg for their life style funding this rebalancing pause/change makes sense to me. At some point you realize it is all on you and the likely recovery might be too little or to late.

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Re: Can you rebalance your way to $0?

Post by The Wizard » Fri Feb 08, 2019 10:11 am

Best way to get to zero is with an individual stock.
Start a few decades ago with $100,000 in Enron stock (for example) and $100,000 in a Treasury bond fund.
Rebalance as needed to stay above 45/55.
That should do it...
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Re: Can you rebalance your way to $0?

Post by carol-brennan » Fri Feb 08, 2019 1:48 pm

nisiprius wrote:
Fri Feb 08, 2019 7:36 am
Since 2008-2009 represented a very bad case, and yet the effect was merely an irritating nuisance, this tells us that the theoretical issue isn't too important in practice.

I think people worry about this because they hate throwing good money after bad when they rebalance during a decline. I hate it myself, during 2008-2009 I basically did nothing. VBINX rebalanced for me, but in my other holdings, I did not rebalance. I didn't sell, good for me, but I couldn't bring myself to buy more, either. Well, it is what it is.
First, thank you tremendously for your response. This (the theoretical result) is exactly the result I was intuiting, but my math skills were not up to the task.

So I'm wondering whether this phenomenon calls into question the relative safety of a fund such as the TSP L fund, which is supposed to provide more protection than growth. I would not be surprised, for instance, to find that the stock market is negative over the next 10 to 20 years. If that were to happen, it would be better simply to set aside a certain amount of funds for "gambling" in the stock market while letting the rest reside in a stable G fund, rather than letting the TSP rebalance daily my entire portfolio down.

Thanks again for that post. That was an award winner, in my book.

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Re: Can you rebalance your way to $0?

Post by carol-brennan » Fri Feb 08, 2019 1:52 pm

nisiprius wrote:
Fri Feb 08, 2019 8:14 am
I'm not sure Carol-Brennan is seriously worried about rebalancing to $0. When this topic has come up before, it's usually been in the general context of "is rebalancing good or bad, necessary or optional, what exactly is it supposed to accomplish, can it actually manufacture extra return out of volatility, is it a formula for buying low and selling high."
No, the real gist of my question was to receive confirmation that rebalancing presupposes that the value of the asset into which you pour funds from other sources will eventually return to "mean" (or go higher, which is what most presume).

Let's say the stock market, having ridden an unprecedented wave of quantitative easing, never returns to the heights it is at now, and also that, as a result of certain industries (such as health care) being socialized as part of a wave of worldwide anti-capitalist sentiment (which seems to be coming), the stock market in fact goes down for the next 20 years. How will the "rebalancers" look at their time-honored practice of rebalancing, when the effect of it ends up being a permanent (in their lifetimes) loss of capital?

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Re: Can you rebalance your way to $0?

Post by carol-brennan » Fri Feb 08, 2019 1:55 pm

nisiprius wrote:
Fri Feb 08, 2019 8:14 am

I'm convinced that rebalancing just isn't a big deal, and that its importance and its effect are exaggerated. My conspiracy theory is that advisors have a temptation to do this. They can frame it as a laborious chore that they can do for you, a valuable service they can point to that justifies their fee. It is in their interests to exaggerate its value, and to present it as something so complicated and arcane (don't just rebalance annually, use rebalancing bands, etc.) that you don't want to try it yourself.

I'm with you here.

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Re: Can you rebalance your way to $0?

Post by carol-brennan » Fri Feb 08, 2019 2:01 pm

Dandy wrote:
Fri Feb 08, 2019 10:05 am
At some point after a prolonged equity decline many retirees will likely stop or under rebalance to preserve what they consider a critical mass of nest egg assets. If they very much rely on their nest egg for their life style funding this rebalancing pause/change makes sense to me. At some point you realize it is all on you and the likely recovery might be too little or to late.
Excellent point.

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Re: Can you rebalance your way to $0?

Post by KlangFool » Fri Feb 08, 2019 2:02 pm

carol-brennan wrote:
Fri Feb 08, 2019 1:52 pm
nisiprius wrote:
Fri Feb 08, 2019 8:14 am
I'm not sure Carol-Brennan is seriously worried about rebalancing to $0. When this topic has come up before, it's usually been in the general context of "is rebalancing good or bad, necessary or optional, what exactly is it supposed to accomplish, can it actually manufacture extra return out of volatility, is it a formula for buying low and selling high."
No, the real gist of my question was to receive confirmation that rebalancing presupposes that the value of the asset into which you pour funds from other sources will eventually return to "mean" (or go higher, which is what most presume).

Let's say the stock market, having ridden an unprecedented wave of quantitative easing, never returns to the heights it is at now, and also that, as a result of certain industries (such as health care) being socialized as part of a wave of worldwide anti-capitalist sentiment (which seems to be coming), the stock market in fact goes down for the next 20 years. How will the "rebalancers" look at their time-honored practice of rebalancing, when the effect of it ends up being a permanent (in their lifetimes) loss of capital?
carol-brennan,

That is why it makes sense to put a limit on rebalancing. Aka, do not rebalance if your fixed income drops to a certain size.

KlangFool

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Re: Can you rebalance your way to $0?

Post by bluquark » Fri Feb 08, 2019 2:11 pm

The problem with this line of thinking is that it assumes stocks can collapse but bonds cannot, but the apparent safety of bonds only started in the 1980s and may someday cease again.

In Weimar Germany hyperinflation destroyed bonds and a few years later the Depression destroyed stocks. In 1970s both stocks and bonds dropped at the same time. In both scenarios, a hypothetical 100% stocks long-term investor came out the other side much better than a 100% bonds investor, because bonds do *not* revert to the mean.

If a gigantic stock market crash happens, I will rebalance to AA not only out of greed but also to avoid being overexposed to inflation.

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Re: Can you rebalance your way to $0?

Post by Starfish » Fri Feb 08, 2019 2:17 pm

carol-brennan wrote:
Fri Feb 08, 2019 6:48 am
Rebalancing presumes a reversion to the mean for the assets held, doesn't it?

What if one of those assets in a portfolio doesn't revert to the mean but stays low or declines for the duration of one's life. Yet one continues to rebalance into that declining asset with the "good money" portion of a portfolio?

How long can one go?

This is the main issue with rebalancing.
Rebalancing is a form of automatic market timing where you buy low and sell high. This assumes that the asset recovers after the drop. If it doesn't you keep buying an asset that keeps going down..

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Re: Can you rebalance your way to $0?

Post by carol-brennan » Fri Feb 08, 2019 2:24 pm

All excellent points to consider. Thanks, everyone.

Something tells me we need to take advantage of the 3.1% you can currently get on 5-year CDs. That return might look darn good just a year from now.

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Re: Can you rebalance your way to $0?

Post by KlangFool » Fri Feb 08, 2019 3:00 pm

bluquark wrote:
Fri Feb 08, 2019 2:11 pm
The problem with this line of thinking is that it assumes stocks can collapse but bonds cannot, but the apparent safety of bonds only started in the 1980s and may someday cease again.

In Weimar Germany hyperinflation destroyed bonds and a few years later the Depression destroyed stocks. In 1970s both stocks and bonds dropped at the same time. In both scenarios, a hypothetical 100% stocks long-term investor came out the other side much better than a 100% bonds investor, because bonds do *not* revert to the mean.

If a gigantic stock market crash happens, I will rebalance to AA not only out of greed but also to avoid being overexposed to inflation.
bluquark,

If you believe this, then, you would

A) Keep your 30 years fixed rate mortgage as an inflation hedge.

B) Keep some physical gold.

Aka, keep more than stock and bond.

KlangFool

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Re: Can you rebalance your way to $0?

Post by David Jay » Fri Feb 08, 2019 3:04 pm

carol-brennan wrote:
Fri Feb 08, 2019 2:24 pm
All excellent points to consider. Thanks, everyone.

Something tells me we need to take advantage of the 3.1% you can currently get on 5-year CDs. That return might look darn good just a year from now.
Are you old enough to remember the inflation of the late 1970s? Fixed, low interest debt instruments weren’t the place to be.
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Re: Can you rebalance your way to $0?

Post by nisiprius » Fri Feb 08, 2019 7:43 pm

bluquark wrote:
Fri Feb 08, 2019 2:11 pm
The problem with this line of thinking is that it assumes stocks can collapse but bonds cannot, but the apparent safety of bonds only started in the 1980s and may someday cease again.

In Weimar Germany hyperinflation destroyed bonds and a few years later the Depression destroyed stocks. In 1970s both stocks and bonds dropped at the same time. In both scenarios, a hypothetical 100% stocks long-term investor came out the other side much better than a 100% bonds investor, because bonds do *not* revert to the mean.

If a gigantic stock market crash happens, I will rebalance to AA not only out of greed but also to avoid being overexposed to inflation.
1) Inflation probably doesn't show mean reversion, true.

2) Bond values, if measured in dollars, not only show mean reversion but are guaranteed to mean revert and to do so on schedule. That is to say, they are guaranteed to return their face value at maturity. If they rise above it before maturity, they will sink to it at maturity. If they fallow below it before maturity, they will rise to it at maturity.

3) TIPS, when measured in real value (inflation-adjusted), are guaranteed to "mean revert" in the sense of point #2. TIPS do exist, and have existed since about 1997. Inflation-linked bonds have existed in other countries for longer periods of time.

4) Stocks are affected by inflation, too. In fact, the full title of the famous "Death of Equities" article in Businessweek was "The Death of Equities: How Inflation is Destroying the Stock Market." Stocks aren't magically immune from inflation in some way that is any different from bonds, they simply have had higher return on the average than bonds.
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Re: Can you rebalance your way to $0?

Post by bluquark » Fri Feb 08, 2019 8:01 pm

nisiprius wrote:
Fri Feb 08, 2019 7:43 pm
4) Stocks are affected by inflation, too. In fact, the full title of the famous "Death of Equities" article in Businessweek was "The Death of Equities: How Inflation is Destroying the Stock Market." Stocks aren't magically immune from inflation in some way that is any different from bonds, they simply have had higher return on the average than bonds.
"immune" would be too strong but they do resist it better. Higher prices turns into revenue for companies so in the long run, stocks should rise at the rate of inflation. In the short and medium term the chaos it causes in liability matching causes a lot of problems for companies so it is indeed bad for them (and it's certainly in no way good for them in real terms). The data from the 1970s is a little bit ambiguous on this on its own, but I'm inclined to attribute the huge stock boom in the 1980s in part to an inflation recovery effect.

The more extreme data from Weimar Germany shows the point more clearly on this. Bonds/cash went to basically zero but stocks only declined by something like 30% in real terms. True, I don't think we really need to be concerned about hyperinflation, only 1970s-style high inflation, but that still indicates there's inherent inflation-protection to stocks.

Like KlangFool said, real estate resists inflation even better. My point is narrowly that if you are choosing between liquid assets, stocks should offer at least moderately better inflation protection, in the long term, than any category of fixed income (even high-yield bonds which otherwise fit your "outrace inflation on average" argument).

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Re: Can you rebalance your way to $0?

Post by 2015 » Fri Feb 08, 2019 8:36 pm

I predict when the next 2008 comes there will be several "catch a falling knife" threads, if only because if gives financial writers of all stripes an excellent way to monetize their writing. The problem is when this question is really going to matter the question won't happen in isolation. KlangFool has repeatedly provided excellent real world examples of what happens when it seems this time the stock market really really really will never come back and one's personal situation is rolling back downhill as well.

I have decided I will stop rebalancing at some point during the next EOTWAWKI event for no other reason than such an action matches my my historical relationship with risk of all kinds. I don't need a theory or a financial writer to tell me to do that.

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Re: Can you rebalance your way to $0?

Post by pdavi21 » Fri Feb 08, 2019 8:56 pm

It would be mathematically difficult (maybe impossible?) for rebalancing to underperform the worst performing asset in your portfolio.
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Re: Can you rebalance your way to $0?

Post by randomguy » Fri Feb 08, 2019 9:01 pm

carol-brennan wrote:
Fri Feb 08, 2019 2:24 pm
All excellent points to consider. Thanks, everyone.

Something tells me we need to take advantage of the 3.1% you can currently get on 5-year CDs. That return might look darn good just a year from now.

I can't see how. If rates drop, you would be better off buying bonds. If rates go up, why would you be happy being locked in at 3.1%?

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Re: Can you rebalance your way to $0?

Post by randomguy » Fri Feb 08, 2019 9:19 pm

nisiprius wrote:
Fri Feb 08, 2019 7:36 am

Since 2008-2009 represented a very bad case, and yet the effect was merely an irritating nuisance, this tells us that the theoretical issue isn't too important in practice.
2008-9 was volatile with sharp drops. It was also very short. Pretty sure the bad cases would be the long draw down. See something 1929-1932 or the Neikki 1989 to about 2009. Rebalancing is a bet that the bounce back will happen before you need the money. So far in US history those time periods have been short. Who knows about the future.

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Re: Can you rebalance your way to $0?

Post by bluquark » Fri Feb 08, 2019 9:28 pm

randomguy wrote:
Fri Feb 08, 2019 9:01 pm
I can't see how. If rates drop, you would be better off buying bonds.
It's exactly the same benefit in that case. The capital gain on a bond fund is the NPV of the amount the CD will yield over the current rate until maturity.

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Re: Can you rebalance your way to $0?

Post by MarkRoulo » Fri Feb 08, 2019 10:14 pm

carol-brennan wrote:
Fri Feb 08, 2019 1:48 pm
nisiprius wrote:
Fri Feb 08, 2019 7:36 am
Since 2008-2009 represented a very bad case, and yet the effect was merely an irritating nuisance, this tells us that the theoretical issue isn't too important in practice.

I think people worry about this because they hate throwing good money after bad when they rebalance during a decline. I hate it myself, during 2008-2009 I basically did nothing. VBINX rebalanced for me, but in my other holdings, I did not rebalance. I didn't sell, good for me, but I couldn't bring myself to buy more, either. Well, it is what it is.
First, thank you tremendously for your response. This (the theoretical result) is exactly the result I was intuiting, but my math skills were not up to the task.

So I'm wondering whether this phenomenon calls into question the relative safety of a fund such as the TSP L fund, which is supposed to provide more protection than growth. I would not be surprised, for instance, to find that the stock market is negative over the next 10 to 20 years. If that were to happen, it would be better simply to set aside a certain amount of funds for "gambling" in the stock market while letting the rest reside in a stable G fund, rather than letting the TSP rebalance daily my entire portfolio down.

Thanks again for that post. That was an award winner, in my book.
There is a Bill Sharpe paper that might interest you : "Dynamic Strategies for Asset Allocation", by Perold and Sharpe.

It discusses rebalancing to a fixed ratio of assets and asset classes.

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Re: Can you rebalance your way to $0?

Post by randomguy » Fri Feb 08, 2019 10:17 pm

bluquark wrote:
Fri Feb 08, 2019 9:28 pm
randomguy wrote:
Fri Feb 08, 2019 9:01 pm
I can't see how. If rates drop, you would be better off buying bonds.
It's exactly the same benefit in that case. The capital gain on a bond fund is the NPV of the amount the CD will yield over the current rate until maturity.
You get your money sooner and you get taxed as LTGC (assuming we are 1 year in the future) instead of OI.

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Re: Can you rebalance your way to $0?

Post by carol-brennan » Sat Feb 09, 2019 7:35 am

randomguy wrote:
Fri Feb 08, 2019 9:19 pm
Rebalancing is a bet that the bounce back will happen before you need the money. So far in US history those time periods have been short. Who knows about the future.
Well said.

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Re: Can you rebalance your way to $0?

Post by longinvest » Sat Feb 09, 2019 9:10 am

Rebalancing is about managing risk exposure. It's my opinion that not willing to rebalance after an asset gets cheaper is an indication of a inappropriate initial asset allocation. I've illustrated this recently in another thread:
longinvest wrote:
Wed Feb 06, 2019 3:30 pm
If, for example, I had a 70/30 stocks/bonds portfolio today but I would be unwilling to rebalance bonds into stocks after they lost 80%, it means that I would be OK with a 14:30 stocks:bonds ratio which is a 32/68 stocks/bonds allocation. It would seem sensible to adopt the 32/68 allocation today and then rebalance my portfolio, even if stocks crashed 80%.

Let's look at the scenario in details, assuming that bonds didn't gain any value during the crash.

We start with a $1,000,000 portfolio.

CASE 1: NON-REBALANCED 70/30 Stocks/Bonds

Stocks crash and lose 80% of their value. The $700,000 in stocks shrinks to $140,000. The $300,000 in bonds holds still. This results into a $440,000 portfolio with a 32/68 stocks/bonds allocation.

CASE 2: REBALANCED 32/68 Stocks/Bonds

Stocks crash and lose 80% of their value. The portfolio is regularly rebalanced 7 times during the crash, everytime stocks lose 20.54% (because (1 - 20.54%)^7 = 20%).

Step 1: Stocks lose 20.54% and drop from $320,000 to $254,272. The portfolio is rebalanced by moving $44,695 from bonds to stocks, resulting into a $934,272 portfolio with a 32/68 stocks allocation. This is a 6.6% loss.
Steps 2 to 7: Same as step 1, but the final outcome, at the end of step 7 is a $621,317 portfolio with a 32/68 allocation.


The final allocation is identical, yet the rebalanced portfolio has an additional $181,317, 41% more than the non-rebalanced portfolio. This isn't a small difference; it's a major difference at both the emotional level, for the investor, and at the lifestyle level that the portfolio allows for.

If the investor is OK with a 32/68 allocation after the 80% crash, he has no reason not to adopt it right now and regularly rebalance.

Vanguard has determined, in its Target Retirement Fund series, that 30/70 stocks/bonds was the place to be in retirement. All Target Retirement funds are eventually merged into the Target Retirement Income fund which has this allocation. In other words, Vanguards thinks that a retirement portfolio should never have less than 30% in stocks and it rebalances bonds into stocks when stocks drop below target.

Investors are often encouraged to hold the highest stock allocation they're emotionally able to tolerate. They could consider, instead, to hold the lowest stock allocation they're emotionally able to tolerate and adjust their financial plan accordingly. On the rebalance date, once a year, they would be unable to leave so little money into stocks when they are down and they would willingly rebalance their portfolio.

Our wiki says:

Stay the course
Once you set up a Boglehead portfolio, the only real course correction needed is to rebalance once per year to bring the stock/bond allocations back to pre-set levels.
Last edited by longinvest on Sat Feb 09, 2019 9:56 am, edited 2 times in total.
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abuss368
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Re: Can you rebalance your way to $0?

Post by abuss368 » Sat Feb 09, 2019 9:26 am

carol-brennan wrote:
Fri Feb 08, 2019 6:48 am
Rebalancing presumes a reversion to the mean for the assets held, doesn't it?

What if one of those assets in a portfolio doesn't revert to the mean but stays low or declines for the duration of one's life. Yet one continues to rebalance into that declining asset with the "good money" portion of a portfolio?

How long can one go?
I feel as if that is our International portion of the portfolio.
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Re: Can you rebalance your way to $0?

Post by longinvest » Sat Feb 09, 2019 9:49 am

abuss368 wrote:
Sat Feb 09, 2019 9:26 am
I feel as if that is our International portion of the portfolio.
Abuss,

If I was not willing to buy an asset at half the price, I wouldn't be willing to hold it at full price!

I would think about the minimum portion of my portfolio that I would be able to tolerate into international securities and change my asset allocation accordingly today. This way, if they went down, I would be be unable to leave so little of my portfolio into them and I would rebalance my portfolio. See this post for an explanation.
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Re: Can you rebalance your way to $0?

Post by Call_Me_Op » Sat Feb 09, 2019 10:35 am

As stated above, theoretically possible but highly improbable. To completely protect against this, just define a floor for your assets. If rebalancing will drop you below the floor, do not do it. Very simple way to fail safe your portfolio. If you do this, the investment in question is free to go to zero without taking you down with it.
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Re: Can you rebalance your way to $0?

Post by dharrythomas » Sat Feb 09, 2019 10:49 am

bluquark wrote:
Fri Feb 08, 2019 8:01 pm
nisiprius wrote:
Fri Feb 08, 2019 7:43 pm
4) Stocks are affected by inflation, too. In fact, the full title of the famous "Death of Equities" article in Businessweek was "The Death of Equities: How Inflation is Destroying the Stock Market." Stocks aren't magically immune from inflation in some way that is any different from bonds, they simply have had higher return on the average than bonds.
"immune" would be too strong but they do resist it better. Higher prices turns into revenue for companies so in the long run, stocks should rise at the rate of inflation. In the short and medium term the chaos it causes in liability matching causes a lot of problems for companies so it is indeed bad for them (and it's certainly in no way good for them in real terms). The data from the 1970s is a little bit ambiguous on this on its own, but I'm inclined to attribute the huge stock boom in the 1980s in part to an inflation recovery effect.

The more extreme data from Weimar Germany shows the point more clearly on this. Bonds/cash went to basically zero but stocks only declined by something like 30% in real terms. True, I don't think we really need to be concerned about hyperinflation, only 1970s-style high inflation, but that still indicates there's inherent inflation-protection to stocks.

Like KlangFool said, real estate resists inflation even better. My point is narrowly that if you are choosing between liquid assets, stocks should offer at least moderately better inflation protection, in the long term, than any category of fixed income (even high-yield bonds which otherwise fit your "outrace inflation on average" argument).
I think Warren Buffett agrees more with nisipruis.

http://fortune.com/2011/06/12/buffett-h ... sics-1977/

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Re: Can you rebalance your way to $0?

Post by bluquark » Sat Feb 09, 2019 3:18 pm

dharrythomas wrote:
Sat Feb 09, 2019 10:49 am
Like KlangFool said, real estate resists inflation even better. My point is narrowly that if you are choosing between liquid assets, stocks should offer at least moderately better inflation protection, in the long term, than any category of fixed income (even high-yield bonds which otherwise fit your "outrace inflation on average" argument).
I think Warren Buffett agrees more with nisipruis.

http://fortune.com/2011/06/12/buffett-h ... sics-1977/
Buffett’s argument was contingent on 1945-1977 US data and his forward-looking assumptions also incorporate dated aspects like corporate CPI-indexed pensions, high dividend tax rates etc.

It looks that there has been a ton of academic research on relationship of stock returns and inflation since then, on bigger and international data sets. The results are complex and mixed but overall seem to support my point of view. For example, this 1993 paper: https://docs.google.com/viewerng/viewer ... lation.pdf and this 1997 paper: https://www.sciencedirect.com/science/a ... 0696000393
Abstract
A large body of evidence indicates that the stock market tends to perform poorly during inflationary time periods. However, these results are mostly obtained from models structured to estimate the short-run relationships between stock returns and inflation. In this paper, we use a reduced-form approach and recent advances in the theory of cointegration to explore the international evidence on the relationship between stock prices and goods prices. This approach allows us to test if stocks maintain their value relative to goods prices and whether these response patterns depend on the source of inflation shocks. For most of the countries analysed, our results indicate that stocks do maintain their value relative to movements in overall price indexes and this conclusion generally does not depend on whether the source of the inflation shock is from the real or monetary sector. One notable exception is that stocks do not maintain their value relative to goods price following real output shocks in the US.

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Re: Can you rebalance your way to $0?

Post by carol-brennan » Sun Feb 10, 2019 9:06 am

longinvest wrote:
Sat Feb 09, 2019 9:49 am

If I was not willing to buy an asset at half the price, I wouldn't be willing to hold it at full price!
What one is willing today to buy at "full price" may look entirely different to you and everyone else by the time it has reached "half price."

Time can change a lot, particularly the perceived value of rules of thumb.

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Re: Can you rebalance your way to $0?

Post by longinvest » Sun Feb 10, 2019 9:11 am

carol-brennan wrote:
Sun Feb 10, 2019 9:06 am
longinvest wrote:
Sat Feb 09, 2019 9:49 am

If I was not willing to buy an asset at half the price, I wouldn't be willing to hold it at full price!
What one is willing today to buy at "full price" may look entirely different to you and everyone else by the time it has reached "half price."

Time can change a lot, particularly the perceived value of rules of thumb.
I try to think about possible (even if unlikely) future scenarios and I don't wait for bad times to happen before adjusting my asset allocation. That's why I think that unwillingness to rebalance after an asset gets cheaper is an indication of an inappropriate initial asset allocation.
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