Does Rebalancing Really Pay Off?

[Lsbcal]

Quote:

Originally Posted by samclem If having an appropriate target AA is the top priority, (and I think it is), then I don't know how rebalancing (or whatever we call the means used to keep the actual portfolio aligned with the AA) could be very far down on the list.

Well you got me on that one.

I guess I was thinking about major rebalancing as some tend towards e.g. market goes down a lot and there are major shifts to rebalance. My rebalance regime is so minor it seems to be way down the lists of concerns. It is designed to be small and incremental.

I recall someone saying that the smarty pants at Yale endowment rebalance daily (as apparantly Vanguard target date funds do). That is really an extreme form of incrementalism.

[NW-Bound]

When I made the posts earlier, I was responding to another post, and it was an interesting discussion but tangential to the topic of the OP. And the latter is about the effects of rebalancing vs. "buy and hold".


I have now read the article in the OP, where the author refuted some claims made by Bernstein. I am not familiar with Bernstein's study to see who is more correct. I also have not fully followed Michael Edesess's method to see if his conclusion is valid.

But I have these two comments to make.

1) In the phase of portfolio draw down, the WR may make a difference. It does not appear that either author considered that.

2) If the 2 authors are looking to maximize the expected return or average return, they are not doing what people here do when running FIRECalc. Most people want to be sure to stay afloat. They are willing to give up the potential for big gains, in return for an assurance of staying afloat. In engineering and optimal control theory, we talk about this "Minimax" problem, which seeks to have the best "worst case" result. And this is the same as the St. Petersburg Paradox I described earlier.

[Lsbcal]

Quote:

Originally Posted by NW-Bound ... But I have these two comments to make. 1) In the phase of portfolio draw down, the WR may make a difference. It does not appear that either author considered that. 2) If the 2 authors are looking to maximize the expected return or average return, they are not doing what people here do when running FIRECalc. Most people want to be sure to stay afloat. They are willing to give up the potential for big gains, in return for an assurance of staying afloat. In engineering and optimal control theory, we talk about this "Minimax" problem, which seeks to have the best "worst case" result. And this is the same as the St. Petersburg Paradox I described earlier.

These are very good points. My comments on them:
1) Withdrawals for spending very definitely are something that I had not really appreciated until it hit us in 2008-2009. Spending in a major down market makes the portfolio shrinkage accelerate as we know intellectually but seeing it happen to you may be a nightmare. We withdrew from FI and let the equity component slide.

2) For me the worst case as demonstrated in our history is 1929 to the bottom in 1932. I design my strategy with this one firmly in mind. Rebalancing into a down market is not for me because I know I could not stomach the ride. Frankly, a well designed market timing scheme could mitigate this but I know I'm in a tiny minority with this opinion.

[NW-Bound]

In real life there are a lot more factors that these studies cannot take into consideration. For example, even if rebalancing proves to be effective in a down market, a person drawing 5% WR will be more reluctant to pull the trigger compared to one drawing 2%. And the 1st person would not be wrong; he had a smaller margin for error if the market dropped more.

In matters like financing and investing, I tend to be more pragmatic and think more about people's psychology, my own included, rather than looking for some sure-fire methods. In my work, I could be a lot more theoretical and exact (one of my jobs had the title of "Scientist" because of the analytical work dealing with equations spanning pages) because I dealt with inanimate objects that could be tested and modeled very precisely. Understanding human emotions, including your own, is more difficult.

[clifp]

Quote:

Originally Posted by NW-Bound In layman's term, even if a bet has a high expected return, and perhaps even infinite, you do not want to take it if it also has a finite chance of bankrupting you. Here's an example. You have $1M. I ask you to flip a coin. Head, you lose your $1M. Tail, I give you $9M for $10M total. The expected value of the bet is $5M, which is 5X what you have now. Do you take the bet? See how hard it is to take the above gamble, let alone the 0.04%/yr advantage?

As PSA if anybody has opportunity to make a coin flip like this I'll happily risk upto $500K in return for $4.5 million. Just make sure the coin flip is done with your coin and not theirs

[NW-Bound]

If one is allowed to bet less than his entire net worth, surely he's a fool not to place a bet. The only question is what percentage of his stash he should bet.

This is somewhat similar to people devoting a portion of their AA to high-risk start ups and IPOs. However, the improbable proposed coin toss has a payout of 9X with a chance of 1/2 thus strongly in your favor, while a start-up has a payout of 100X perhaps, but its probability of success may be much less than 0.01, such as during the dot com era.