When does rebalancing become market timing?

[karluk]

Today I sold about $18,000 worth of stock mutual funds to get back within my target asset range. Routine rebalancing, right? Well, not quite. It was a delayed implementation of the rebalancing I normally would have done at the end of December in order to start the New Year fresh. I intentionally held off on my year end rebalancing because it was looking as if there would be a resolution to the fiscal cliff negotiations, and I didn't want to miss out on a potential relief rally.

Well, things worked out ok on that guess, so now I'm properly balanced and can forget about rebalancing for a while, right? Well, not quite that either. I suspect that there will be some bumpy days ahead because of the debt ceiling issue. I know I'll be following the market over the next month or so, hoping for an opportunity to repurchase my shares at a lower price.

I've done this sort of dual purpose rebalancing many times over the years, generally with favorable results. It has become a little hobby of mine that I thoroughly enjoy. I am probably rationalizing, but I figure that allowing myself the flexibility to decide when to rebalance puts me in a no lose situation. If I guess wrong and the market continues to go up after I sell, I've accomplished my goal of reducing risk and getting back to my target asset allocation. If I'm lucky enough to guess the market's direction correctly, I get to make a little money by repurchasing shares at a lower price.

Do other people do the same thing? If so, what is your experience?

 

[jon-nyc]

I suppose when it ceases to follow your investment policy it's market timing.

And to answer your other question I' also often a tad flexible on when I rebalance.

 

[HighRoller]

I don't keep what I consider a lot in stocks but I do allocate some of my cash for "buying in" on what I consider good market dips for certian DOW stocks that I track closely. I suspect a lot of folks with spare cash do the same.

 

[mathjak107]

When you think you are going to beat the markets at their own game by picking the best time to rebalance- thats timing.

When you say i will except wherever the market is when it is time to rebalance either by calander or predetermined percentages that is not timing.

 

[W2R]

Make a written investment plan. In that plan specify what the triggers will be to rebalance. For example, "I will rebalance during the first week in January each year, and additionally if my asset allocation becomes incorrect by 3%" or some such thing. Then, rebalance only according to that plan. Then you are not market timing.

 

[Closet_Gamer]

If it works, its well managed asset rebalancing.

If it doesn't, it was ill advised market timing.

Sounds like you've been rebalancing to me.

 

[ziggy29]

Make a written investment plan. In that plan specify what the triggers will be to rebalance. For example, "I will rebalance during the first week in January each year, and additionally if my asset allocation becomes incorrect by 3%" or some such thing. Then, rebalance only according to that plan. Then you are not market timing.

This. If you only rebalance according to predefined objective triggers, and not just at random intervals because of a gut feeling, then it's not market timing.

 

[photoguy]

It's all a matter of intention.

 

[easysurfer]

Make a written investment plan. In that plan specify what the triggers will be to rebalance. For example, "I will rebalance during the first week in January each year, and additionally if my asset allocation becomes incorrect by 3%" or some such thing. Then, rebalance only according to that plan. Then you are not market timing.

+1

For me, I've decided to just rebalance during the first week of January each year and that's what I did in early Jan.

That said, I almost gave into temptation by having an internal conversation such as "Should I wait until the end of Jan in case there's a large January effect?"

 

[kaneohe]

Today I sold about $18,000 worth of stock mutual funds to get back within my target asset range. ..................

I know I'll be following the market over the next month or so, hoping for an opportunity to repurchase my shares at a lower price.

.....just curious.........if the first action is a rebalance and aligns things properly, what does the second do?

 

[NW-Bound]

This question has come up in a long-ago thread.
I don't care what people call themselves, but I call myself a market timer. However, I consider myself clean and not at all dirty.

If it works, its well managed asset rebalancing.

If it doesn't, it was ill advised market timing.

Sounds like you've been rebalancing to me.

It is similar to the difference between a revolutionary hero vs. a dirty rebel. The first was successful and became the ruler, while the latter got captured and executed in a public square.

A successful market timer gets rich, and is honored as a wise contrarian investor. An investor who loses money through ill-timed market moves gets poor, and is called dirty to rub insults to his injuries.

 

[rbmrtn]

I don't care what people call themselves, but I call myself a market timer. However, I consider myself clean and not at all dirty.

Same.

 

[NW-Bound]

Whatever...

It's all a matter of intention.

Isn't the intention always either to have more money, or less volatility?

 

[jollystomper]

My own approach is to check at the beginning of each quarter, and only if my target allocations are more than 2% out of alignment then I'll rebalance.

I have a very small amount (1.5% of total savings/investments) set aside for buying opportunities for individual stocks, but I consider this money that if it disappeared I could live with. Even then I buy with the intent to hold for a long time (at least 5 years) unless the company fundamentals change.

 

[karluk]

.....just curious.........if the first action is a rebalance and aligns things properly, what does the second do?

Let's take yesterday's transactions as an illustrative example. By my calculations, I am now $311.46 below my target percent for equities. If the market declines from here by as little as 3%, I can repurchase the entire $18,000 of yesterday's sale and remain within my target percent. My hoped-for profit would be 3% of $18,000 = $540.

That's what happens if I guess right. If I guess wrong and never have a chance to repurchase, I will wait patiently, doing nothing, until it's time to rebalance again.

 

[karluk]

If it works, its well managed asset rebalancing.

If it doesn't, it was ill advised market timing.

Sounds like you've been rebalancing to me.

I love your comment. It's a very witty way of looking at it. I don't mind being accused of "ill advised market timing" when I'm wrong, as long as I can show off my "well managed asset rebalancing" skills when I'm right.

My latest sale could easily turn out to be ill advised. Word from Washington is that Congress, in a rare display of ordinary common sense, may be backing away from a confrontation over the debt ceiling. We'll see how it goes.

 

[kaneohe]

Let's take yesterday's transactions as an illustrative example. By my calculations, I am now $311.46 below my target percent for equities. If the market declines from here by as little as 3%, I can repurchase the entire $18,000 of yesterday's sale and remain within my target percent. My hoped-for profit would be 3% of $18,000 = $540.

That's what happens if I guess right. If I guess wrong and never have a chance to repurchase, I will wait patiently, doing nothing, until it's time to rebalance again.

if the market continues to drop (e.g -50%), wouldn't you have been better off not doing that purchase at -3% but at -50% instead? so not clear which is better?

 

[karluk]

if the market continues to drop (e.g -50%), wouldn't you have been better off not doing that purchase at -3% but at -50% instead? so not clear which is better?

A repurchase at -50% is clearly better than a repurchase at -3%. My willingness to repurchase quickly after only small declines makes my strategy most successful during periods of relatively flat markets with high volatility. Specifically, I did extremely well during the European debt crisis talks in the spring and summer of 2010 and also during the US budget negotiations during the summer and early fall of 2011.

But my strategy is also self correcting, in the sense that if I did repurchase at -3% and then got an additional decline to -50%, I would revert back to being a traditional rebalancer. We saw that exact scenario in 2008. I made several profitable in-out trades early in 2008, but then spent the rest of the year rebalancing into the teeth of the worst market decline in my lifetime. I ended the year with about $150,000 of net stock purchases, which as you know have roughly doubled in subsequent years.

So my strategy really is a hybrid. It looks a lot like market timing during periods when the market is seeing swings both up and down, but when the direction is almost exclusively either up or down, I act like a rebalancer.

 

[Closet_Gamer]

Now that used up all my meager wit in my first post, I have to admit that I've been noodling this a bit.

I'm a pretty dedicated,"I have a written plan, rebalance and don't screw with it" guy. I've got 10 years of good discipline there. (I did flinch and move some college funds when the DOW was at 7000...not totally out of the market, but I've under-performed vs having just left it alone. Fear. Not good.)

That said, on the heels ofthe big crunch a couple years back, a Warren Buffett quote has been ringing in my ears. It was something to effect that "We had a gross under-pricing of risk. Investors weren't demanding enough return for the risks they take."

With that persepctive, I have become far more willing to look at the absolute return of an asset class and say "not worth it right now" even if that's against the grain of my AA. For example, I recently exited Muni bonds all together. Meager interest returns, limited upside, big potential downside if CA or IL default and scare the heck out of everyone. I'm out for now. Its still in my target AA but I've decided that the downside risk isn't warrented by the upside exposure. Sort of like saying "I bike for 1 hour every day" but then noticing huge dark clouds and saying "Still true...but not today." I might miss a great ride on a beautiful day...but more likely I'll avoid huddled on some strangers porch as the lightning flashes.

So I think I've essentially modified my AA strategy:

I have a disciplined AA but that discipline includes being aware of the absolute returns on an asset class and being willing to forgo a few points of upside to eliminate a drastic downside.

There...I'll stop rationalizing in public now. Thanks for letting me talk it out ;-)

 

[REWahoo]

So I think I've essentially modified my AA strategy:

I have a disciplined AA but that discipline includes being aware of the absolute returns on an asset class and being willing to forgo a few points of upside to eliminate a drastic downside.

A great strategy - provided you have the correct analysis. Markets and asset classes often perform far differently than the best analysis indicates. Zigging when you need to zag (as in your college fund example) is often worse than holding your nose and rebalancing, ignoring the cries of "Dow 20,000!" and/or "Doomsday Looms Ahead!".

But I do agree it is difficult to stay the course when there is so much noise about what is sure to happen...

 

[photoguy]

Isn't the intention always either to have more money, or less volatility?

Well, the way I view it is whether the intent is to exceed market returns because I have a prediction of how they will behave. In Dec. if I believe the market will go up in Jan because the fiscal cliff will be resolved and I delay selling equities to bonds -- I would say this is market timing.

I think you can be a market timer even if you use completely mechanical rules. E.g., buy $X of equities when the 50 day moving average is above the 200 day moving average. The 'intent' of rules like this is to capture trends in the market which hopefully extend into the future.

In my view, rebalancing is about maintaining a constant risk portfolio as set out in your asset allocation. E.g., for a 60-40 portfolio a 50% market decline results in a 30% portfolio drop. If equities do well for a number of years and you don't rebalance, you will face potentially larger worst case portfolio declines. In this case I think rebalancing would actually lower future returns as equities have higher expected returns.

 

[kaneohe]

So my strategy really is a hybrid. It looks a lot like market timing during periods when the market is seeing swings both up and down, but when the direction is almost exclusively either up or down, I act like a rebalancer.

I admire your ability to admit that your strategy is a hybrid.......and I can see that for some, a little added excitement gives life some extra zest
I'm not a serious student of rebalancing so I don't know the academic theories,etc. It is intuitively obvious (and hopefully also correct) to me that if you have a large decline and then rebalance, that you will gain on the recovery. It is not so obvious to me that if you rebalance every 3% on the way down that the same is true.........

 

[ERhoosier]

Wouldn't get too hung up on specific rebalancing deadlines. Prob for lor logistical reasons, most balanced funds have some flexibility in timing of trades. OTOH if you are motivated by predicted market swings.....

 

[NW-Bound]

Well, the way I view it is whether the intent is to exceed market returns because I have a prediction of how they will behave...

Some people who rebalance based on a predetermined threshold can indeed do well. They claim that they make no prediction of the future market, but they really do. Implicit in the rebalancing act is the belief that "what asset class goes up relative to another will come back down, and vice versa".

Seriously, I think the "dirty market timers" are derided because they are so cocky sure of their prediction of the short-term market movements, and go "all in" or "all out". Such drastic movements do not pay out over time. The exact timing is too difficult to predict.

On the other hand, even rebalancers who claim to be pure are still interested in and talk about economic cycles, secular and cyclical market bear/bull cycles, how the bond market has been enjoying such a long bull cycle which may not last, etc...

They say that it is only for talk, and they do not trade based on it. Fine, but I find it curious. For example, I do not care about spectator sports, and as I do not concern myself with which team will prevail, I do not follow any news about which players have joined which team, etc... I do not even know which team is playing against whom. Why should I?

All this is to suggest that there is some "market timing" in all of us. It's just a matter of degree. Although I have repeatedly [-]admitted[/-] claimed to be a market timer, I can never be that sure about my predictions. Hence, I only varied my AA a bit based on what I perceive as where we are in the economic cycle. And I found out that that is called "Tactical AA". Whatever...

If equities do well for a number of years and you don't rebalance, you will face potentially larger worst case portfolio declines. In this case I think rebalancing would actually lower future returns as equities have higher expected returns.

Yes, during the bull period of 1980-2000, rebalancing out of a long rise of the market would reduce one's return. By the way, Bogle, in a recent interview, said that he was not much of a rebalancer, because that meant selling out of a good rising asset.

And even if one does not rebalance because "equities have higher expected returns" as is commonly believed, that's still a bet that the future will be like the past. You see, one is always making a prediction, and the difference is simply about the time scale. The dirty market timer tries to predict the short-term movements, while the clean rebalancers are betting that stocks and bonds will return to their historical returns in the long run (how long though?). What do the latter base their belief on, other than faith?

And then, there are people who look much further ahead and think of the rise/fall of economic empires, while the others say that nah, the US is special and will not suffer the same fate as the Spanish and British Empires. We are all making bets about the future here.

 

[photoguy]

All this is to suggest that there is some "market timing" in all of us. It's just a matter of degree. Although I have repeatedly [-]admitted[/-] claimed to be a market timer, I can never be that sure about my predictions. Hence, I only varied my AA a bit based on what I perceive as where we are in the economic cycle. And I found out that that is called "Tactical AA". Whatever...

I have to admit that recently I hit my bounds for REITs in my allocation (target=10% actual=12.5% which is at the trigger threshold) . I delayed rebalancing because I was lazy and maybe I succumbed to the magical thinking that hey there's a momentum effect so I should let it ride a bit. If I had rebalanced, I would have moved from reits to international (this was before the runup in the last few months).

And even if one does not rebalance because "equities have higher expected returns" as is commonly believed, that's still a bet that the future will be like the past. You see, one is always making a prediction, and the difference is simply about the time scale. The dirty market timer tries to predict the short-term movements, while the clean rebalancers are betting that stocks and bonds will return to their historical returns in the long run (how long though?). What do the latter base their belief on, other than faith?

For me, it would be results from about the last hundred years. I know that the data points are not strictly speaking "independent" and the US may be susceptible to survivorship bias. But this belief is also supported by a logical mechanism (risk reward story, efficient information transmission, etc.) which lends strength to the data (or maybe it is the other way around and the data supports the theory).