Did rebalancing help?

[harley]

I've read a lot of threads decrying the return in the equities market over the last decade or so as an example of why AA doesn't work. I personally spent that time with my money in the tender care of a commission based FA, so I'm sure I made tons of money over that period.

However, those of you who have been doing AA for a while, did you really lose all the money you had made (on paper) during this period? In other words, even though the S&P is about where it was 12 years ago, if you've been rebalancing regularly it seems you should have beat the market over that time, harvesting winners and buying low.

Is this accurate, or am I missing something? Or is that already built into the equation? It doesn't seem so. I'm going to be doing this going forward, and I'm curious about how it's been working in real life.

 

[ziggy29]

In the tech-led 2000-2002 bear market, rebalancing worked in a big way. While the Naz was dropping 75% and the S&P was dropping 50%, small cap value was up sharply, REITs were up sharply, emerging markets were up a bit and gold miners went through the roof.

As I had all of these in my AA and rebalanced annually, my total loss from 2000 to 2002 was about -10%, compared to something like -40% on the S&P 500. In 2002 in particular, when the S&P 500 was down 22%, I was down 5.4%.

As a result, I'm only back to about early 2003 levels, not 1997 levels -- even if I strip out new contributions since the bear started.

This bear, on the other hand, is a whole 'nother story. I could be wrong, but I think we may be getting close to the stage in this bear market where we're going to start seeing at least *some* significant diverge in equity asset class performance. So far it's barely mattered on the way down, but I'm seeing signs in the market that there seems to be less movement in lockstep.

 

[DblDoc]

Sometimes it helps, sometimes it hurts but generally over the long term it helps with yield - a little. It is mostly a risk management strategy so you don't end up overweighted in any one asset class and subject to large losses. I agree with ziggy about the correlations becoming less than 1.00 as I find that I am having to redirect new money into different classes each month.

DD

 

[Alan]

I was regularly selling stock fund shares and buying bond fund shares during the 90's and in reverse during 2000-2002.

I had a return of -16.25% last year and -7.2% so far this year. My returns during 2000-02 were -2.6%, -4.4% and -11%.

However, IRR over last 12 years is 6.5% and over last 10 years is 3.3%. I've personally re-balanced 3 times in the last 18 months and I assume the manager of the Wellesley fund shares I own has re-balanced several times to maintain that funds stated objective, so I still strongly believe re-balancing to a target allocation works.

 

[FUEGO]

I usually "rebalance" by directing new purchases to the most underweight asset classes. Last year I was down 37% on a portfolio that is 100% equities, 1/2 domestic and 1/2 international (down 38% and 44% for their broad indexes, respectively). So I beat both indexes for the year, but I was also directing contributions to a few asset classes that were 2/3 off at some points last year, and those have outperformed relative to the rest of my portfolio and the broad market (emerging markets comes to mind).

In general, my strategy has me buying the most depressed asset classes at any given time. My latest purchase was US small cap value, which I was way underweight on and I noticed it had dropped about 10% more than the broad US market.

From my vague recollections, in most recent years I performed about as well as the US market in the worst years and outperformed by a decent amount in the best years.

I'll also add that I have a huge allocation to international, emerging markets, small, small value, value, intl value, etc compared to the broad markets and the typical portfolio I see here, so generally I expect more volatility in each asset class but (hopefully) slightly higher long term returns and some overall volatility dampening from owning what remains to be non-perfectly correlated asset classes.

 

[LOL!]

What do you mean "beat the market"? If I was allocated into passively-managed index funds of equities and bonds over the last 12 years, I think rebalancing give one no more than a 1% edge the market of equities and bonds with my same asset allocation.

If you mean beat the S&P500, well, that's a completely different benchmark usually used by financial advisors when it suits them.

 

[harley]

What I mean is that when people/pundits talk about the market (whichever index) being down a certain amount, or down to 1997ish levels, aren't they talking about what you would have if you had put say $10K into that index, reinvested dividends, and otherwise left it alone? But if you had put in your $10K, reinvested dividends, and rebalanced that index along with all your other $10Ks in other indexes, wouldn't you be in better shape than what they are showing?

Of course, I guess that works the other way too. If the market is only going up, you'd lag the index a little because you'd be taking money off the table each rebalance, and putting it into a lower performer. I guess there's really no way to tell where you stand, other than by tracking your own real time performance over time. Or maybe there are ways to do these kinds of calculations, and I just don't have the math.

 

[mathjak107]

rebalancing works when markets slide downward and other asset classes rise but dosnt work well in extended downturns or extended bull markets in an asset class .

your selling the winners to soon and adding money to whats still loosing...

there really isnt a firm answere, depends where you are in the scheme of things

 

[Alan]

What I mean is that when people/pundits talk about the market (whichever index) being down a certain amount, or down to 1997ish levels, aren't they talking about what you would have if you had put say $10K into that index, reinvested dividends, and otherwise left it alone? But if you had put in your $10K, reinvested dividends, and rebalanced that index along with all your other $10Ks in other indexes, wouldn't you be in better shape than what they are showing?

Of course, I guess that works the other way too. If the market is only going up, you'd lag the index a little because you'd be taking money off the table each rebalance, and putting it into a lower performer. I guess there's really no way to tell where you stand, other than by tracking your own real time performance over time. Or maybe there are ways to do these kinds of calculations, and I just don't have the math.

I don't re-balance within an index I re-balance between indexes of asset classes. I might have 50% in VG Total Stock Market and 50% in VG Total Bond Market.

If they say the market is back at 1997 levels then if I had put $10K in the total stock fund and not touched it then I would expect to have $10k in it now. However, I would have had 10K in bonds in 1997 and each year I would have moved some money between the 2 funds to maintain my 50/50 split so it would depend on the rise and fall of both funds as to how much I had today - it could be more than 20k or less, but would be split 50/50.

SIMPLE example (that I'm sure to mess up):

Year one stocks go up 10% and bonds stay flat, you make 1,000 and move 500 to bonds at end of year.

Year two stocks go up 10% and bonds stay flat, you make 1050 on stocks and move 525 to bonds.

Year three stocks go down 17% and bonds stay flat, you lose 1,654 on stocks and your total in your stock fund is $9,371 and in your bond is is $11,050 for a total of $20,421.

If you had never re-balanced your stocks would be at $10,043 and bonds still at $10,000 giving a total of $20,043.

 

[Rich_by_the_Bay]

Sometimes it helps, sometimes it hurts but generally over the long term it helps with yield - a little. It is mostly a risk management strategy so you don't end up overweighted in any one asset class and subject to large losses. I agree with ziggy about the correlations becoming less than 1.00 as I find that I am having to redirect new money into different classes each month.

I have the same take on rebalancing, but the various recommendations that I've read are either mostly theoretical or are based on historic or Monte Carlo modeling which may or may not pan out.

The one consistent theme I hear is not to rebalance too often or with too light a trigger; let them ride a year or two or more before touching up.

 

[Animorph]

I've done plenty of rebalancing in the past two years, but the one that sticks out was selling some of my energy funds when they were +20% of target (so they were 12% of portfolio instead of 10%), bringing them back to target, and then not long after that buying more energy shares when they fell to -20% of target. Sold high and bought back low, had cash left over to put elsewhere.

Rebablancing is only supposed to contribute about a 1% per year boost, so you may not notice it short term. Certainly in terms of cash/equities the gains have yet to be realized.

 

[Jsut]

Maybe It Helps

This is my first post and I am going to do something I should NOT do, math. I used the returns + dividends from the Yahoo site for VTSMX and VBMFX and it seems from Jan 98 to today rebalancing on the first of Jan every years does make you a little more in the end.

50-50
Without Rebalancing
$10,000 in VTSMX in Jan 1998 gets you $10,642 today.
$10,000 in VBMFX in Jan 1998 gets you $18,294 today.
Total of $28,937

Rebalanced Every Jan
$10,000 in VTSMX in Jan 1998 gets you $15,105 today.
$10,000 in VBMFX in Jan 1998 gets you $15,000 today.
Total of $30,105


70-30
Without Rebalancing
$14,000 in VTSMX in Jan 1998 gets you $14,900 today.
$6,000 in VBMFX in Jan 1998 gets you $10,976 today.
Total of $25,876

Rebalanced Every Jan
$14,000 in VTSMX in Jan 1998 gets you $18,768 today.
$6,000 in VBMFX in Jan 1998 gets you $7,987 today.
Total of $26,755

So it seems like either of these typical allocations make you a little more since Jan 1998 if you rebalanced annually.

But then I could be COMPLETELY WRONG!

GM

 

[charlie]

I agree with DblDoc on the risk management benefit.

Frankly, I think that balanced funds, for most people, are great because they
take the emotional out of rebalancing. And, for after tax money, they avoid
creating "taxable events" that would otherwise occur.

In my case, we have settled on the Vanguard Managed Payout and Distribution
fund for our taxable account and have elected to reinvest until we need the
payout. I also use this fund along with Wellesley, some inflation indexed bonds,
GIM and the Vanguard Investment Grade Corporate fund in my IRA.

Cheers,

charlie

 

[haha]

I agree with DblDoc on the risk management benefit.

Frankly, I think that balanced funds, for most people, are great because they
take the emotional out of rebalancing. And, for after tax money, they avoid
creating "taxable events" that would otherwise occur.

How? Funds are just conduits. If they realize CGs to rebalance, those CGs get allocated to each taxpayer fund-holder. If they rebalance when neither asset class has increased, no CG.

Same if you hold the two funds separately. If you rebalance because something has gone up, you geta CG. If on the other hand you rebalance because they have both gone down, but one more than the other, no CG.

Where does the tax benefit enter? I must be missing something.

Ha

 

[charlie]

HaHa, I did not mean to imply there was a tax benefit to owning balanced funds.

I said you will avoid "taxabe events". That is, transactions that require
IRS reporting regardless of profit or loss.

I like to keep my tax reporting as simple as possible.

I hope this reply is an adequate response.

Cheers,

charlie

 

[haha]

HaHa, I did not mean to imply there was a tax benefit to owning balanced funds.

I said you will avoid "taxabe events". That is, transactions that require
IRS reporting regardless of profit or loss.

I like to keep my tax reporting as simple as possible.

I hope this reply is an adequate response.

Cheers,

charlie

OK Charlie, thanks, I understand.

Ha

 

[ERD50]

This is my first post and I am going to do something I should NOT do, math. I used the returns + dividends from the Yahoo site for VTSMX and VBMFX and it seems from Jan 98 to today rebalancing on the first of Jan every years does make you a little more in the end.

50-50
Without Rebalancing
$10,000 in VTSMX in Jan 1998 gets you $10,642 today.
$10,000 in VBMFX in Jan 1998 gets you $18,294 today.
Total of $28,937

Rebalanced Every Jan
$10,000 in VTSMX in Jan 1998 gets you $15,105 today.
$10,000 in VBMFX in Jan 1998 gets you $15,000 today.
Total of $30,105


70-30
Without Rebalancing
$14,000 in VTSMX in Jan 1998 gets you $14,900 today.
$6,000 in VBMFX in Jan 1998 gets you $10,976 today.
Total of $25,876

Rebalanced Every Jan
$14,000 in VTSMX in Jan 1998 gets you $18,768 today.
$6,000 in VBMFX in Jan 1998 gets you $7,987 today.
Total of $26,755

So it seems like either of these typical allocations make you a little more since Jan 1998 if you rebalanced annually.

But then I could be COMPLETELY WRONG!

GM

I did not check your math, but I suspect it is correct. I've looked at this before and I tend to see the same thing - some advantage but not "WOW!".

I think it makes sense to rebalance though. After all, you chose a certain AA to match your risk tolerance, so why not stick to it? It's mechanical, so it helps keep emotion out if it. Although there was a recent thread where people were feeling anxious about rebalancing with all the current uncertainty. So it can't take all the emotion out of it, but these have been extreme times.

Good info, thanks for posting it.


-ERD50

 

[cardude]

Just for comparison, I don't rebalance on any schedule but just let the winners ride until I feel like they are correctly valued and then I sell some/all and hold cash/equivalent until I find something else to buy in to, or I buy back into the same stock if I still like the fundamentals.

I am doing this with individual stocks, not funds, so my risk could be higher if I get it wrong, but so far I'm back to 4/2006 levels after the latest runup in the market vs. about 6-7 years of non-performance on the sp 500. I'm not real happy with that, but it is better.

FWIW I started doing this while still working and am only recently retired, and I'm not really sure if I have the stomach to keep doing it now that I really NEED the money to live on. However, the long 6-7 year span of overall market (sp 500) non-performance gives me pause of doing the market proxy thing and the cooresponding drop in almost all asset classes gives me more pause about the standard diversification thing.

I'm thinking about keeping 25-50% in the one publicly traded company that I think I know enough about, 25% into rental real estate for cash flow/hard asset/inflation hedge, and the rest in cash/equivalents for safety and opportunities.

 

[haha]

I'm thinking about keeping 25-50% in the one publicly traded company that I think I know enough about, 25% into rental real estate for cash flow/hard asset/inflation hedge, and the rest in cash/equivalents for safety and opportunities.

Americredit? AutoNation? CarMax?

Where will you put your chips?

Ha

 

[Gone4Good]

So it seems like either of these typical allocations make you a little more since Jan 1998 if you rebalanced annually.

I did not check your math, but I suspect it is correct. I've looked at this before and I tend to see the same thing - some advantage but not "WOW!".

What's missing from the calculation is the path you took over 10 years to get to these results. By your math, rebalancing resulted in a modest improvement in returns (4.2% annually vs. 3.8% for a 50/50 portfolio) but the volatility of the rebalanced portfolio is substantially less.

Higher returns plus lower volatility =

(It also equals a greater chance of portfolio survivability)



Jsut, if you still have the spreadsheet where you performed the original calculations, could you post the standard deviation of the year-end balances for each of the portfolios? I think that would be illuminating.

 

[Gone4Good]

I'm thinking about keeping 25-50% in the one publicly traded company that I think I know enough about.

Wow.

I'm of the view that an external observer (or even an insider) can't possibly know enough about a company to take that kind of risk.

 

[cardude]

Americredit? AutoNation? CarMax?

Berkshire Hathaway

I'm of the view that an external observer (or even an insider) can't possibly know enough about a company to take that kind of risk.

You are probably right, and it is certainly not the recommended AA. I had been trying to diversify out of Berkshire the last few years, but the net effect of that diversification has been negative so far compared to Berkshire's returns and so my BRK percentage is still very high. I diworsified in other words.

I guess the reason my risk tolorance has been so high is because I've never had a real job but always worked on commission or owned a business. When I owned the business all my eggs were in that one basket and it paid off pretty well (except for my exit strategy). I funnelled almost all of the profits of the businness into Berkshire over the years and that has paid off pretty well. So, I guess old habits are hard to break, but now that I'm not working I am having second thoughts about blowing myself up.

If Berkshire failed and I had 50% AA would it blow me up? Yes. Well, it would blow retirement up and I would have to go back to work.

25%? I think I can cut expenses to still stay in ER at this level.

How could Berkshire blow itself up ?
1. Sell a bad reinsurance policy-- they actually did this back around 911 when they realized a large policy didn't have WMD disclaimers on it so that was scary.

2. Next management team is ineffective-- I don't think they will hire someone stupid, but they could certainly become arrogant or ineffective over the years so there is risk over time they may not do well so the new team would be on a short leash.

3. Warren/Charile die-- that is certain to happen and while it will cause ST price pressures it will not IMO kill the company unless #2 above happens. May see a dividend goinig forward with new management if they are unable to spot good uses for capital, which would be fine with me.

What are the odds Berkshire will totally blow itself up? 1-5% maybe?

I wonder what the odds makers would have said about Lehman, Bear, et al about blowing up in comparison to Berkshire. Their balance sheets were way overleveraged compared to Berkshire's, and the risk model they used, VaR, ( Yappa Ding Ding: Risk Part 3: Case Study - How Poor Risk Management Caused the Crisis) focused on the 95-99% of the time the system did work but ignored the 1-5% when it didn't work. Much of the probability and statistics work—for instance, Monte Carlo simulations like in Firecalc—are based upon thousands and thousands of spins of the wheel. But if you kill yourself that one time, you can’t spin again.

In the current crisis, it has turned out that the unlucky outcome was far more likely than the backtested models predicted. What is worse, the various supposedly remote risks that required trivial capital are highly correlated; you don’t just lose on one bad bet in this environment, you lose on many of them for the same reason. This seems to be what happened to the traditional divirsification across different asset classes-- the different classes were actually closely correlated and the entire portfolio went down. I guess my point is if you divirsify across different asset classes according to standard theory but you really don't understand the correlation because you really don't understand what's in all the asset classes, then you could be in trouble in times like we are having now.

So yes, my underdivirsification is a risk, but hopefully one I can quantify so it doesn't blow me up.

Thoughts?

 

[haha]

Berkshire Hathaway



You are probably right, and it is certainly not the recommended AA. I had been trying to diversify out of Berkshire the last few years, but the net effect of that diversification has been negative so far compared to Berkshire's returns and so my BRK percentage is still very high. I diworsified in other words.

I guess the reason my risk tolorance has been so high is because I've never had a real job but always worked on commission or owned a business. When I owned the business all my eggs were in that one basket and it paid off pretty well (except for my exit strategy). I funnelled almost all of the profits of the businness into Berkshire over the years and that has paid off pretty well. So, I guess old habits are hard to break, but now that I'm not working I am having second thoughts about blowing myself up.

If Berkshire failed and I had 50% AA would it blow me up? Yes. Well, it would blow retirement up and I would have to go back to work.

25%? I think I can cut expenses to still stay in ER at this level.

How could Berkshire blow itself up ?
1. Sell a bad reinsurance policy-- they actually did this back around 911 when they realized a large policy didn't have WMD disclaimers on it so that was scary.

2. Next management team is ineffective-- I don't think they will hire someone stupid, but they could certainly become arrogant or ineffective over the years so there is risk over time they may not do well so the new team would be on a short leash.

3. Warren/Charile die-- that is certain to happen and while it will cause ST price pressures it will not IMO kill the company unless #2 above happens. May see a dividend goinig forward with new management if they are unable to spot good uses for capital, which would be fine with me.

What are the odds Berkshire will totally blow itself up? 1-5% maybe?

I wonder what the odds makers would have said about Lehman, Bear, et al about blowing up in comparison to Berkshire. Their balance sheets were way overleveraged compared to Berkshire's, and the risk model they used, VaR, ( Yappa Ding Ding: Risk Part 3: Case Study - How Poor Risk Management Caused the Crisis) focused on the 95-99% of the time the system did work but ignored the 1-5% when it didn't work. Much of the probability and statistics work—for instance, Monte Carlo simulations like in Firecalc—are based upon thousands and thousands of spins of the wheel. But if you kill yourself that one time, you can’t spin again.

In the current crisis, it has turned out that the unlucky outcome was far more likely than the backtested models predicted. What is worse, the various supposedly remote risks that required trivial capital are highly correlated; you don’t just lose on one bad bet in this environment, you lose on many of them for the same reason. This seems to be what happened to the traditional divirsification across different asset classes-- the different classes were actually closely correlated and the entire portfolio went down. I guess my point is if you divirsify across different asset classes according to standard theory but you really don't understand the correlation because you really don't understand what's in all the asset classes, then you could be in trouble in times like we are having now.

So yes, my underdivirsification is a risk, but hopefully one I can quantify so it doesn't blow me up.

Thoughts?

Good post. You clearly understand what you are about, and understand the risks.

Tax consequences of various strategies can be important. If you have been buying BRK for years, you likely have a great deal of embedded capital gains. This makes any move out of that stock expensive. If you are still confident in its future, all you have to do is peel off a few shares from time to time. But a big sale to get more diversification could cost you a lot. At least with Warren you have honestly, and you and he are on the same side of the ball.

Similarly I favor trying to look ahead during mid-career, and setting up a portfolio of growing dividends. If you are successful, you have no "accumulation/distribution" phases, just a time when you are re-investing dividends, and a time when you are using them to live. This changes the game from seeking portfolio growth, which will then be sold off to pay bills, to seeking a growing income stream. This latter is not necessarily easy either, but since it is somewhat different from what most portfolio managers are seeking, there is less competition.

I believe that a large risk which is currently being underbid is inflation and rising interest rates. True, as long as the world economy is dead there may not be much, but even that is not really sure. I believe that I read in FT recently that last month the UK annualized rate of their version of CPI was >3% year over year.

As I see it, no rule of thumb is much use right now. It really boils down to pay your money, and take your choice.

Regarding risk tolerance, IMO the only way to take risk out of the act of living without paid labor is to log in your years at Uncle Sam's. Many of the retired guys I know are living off some land contracts, or maybe the paper from financing sale of a gas station or other mundane small business.

The way I look at it, compared to these guys my modestly concentrated portfolio of mostly well financed stable businesses looks pretty good. And, although I have been divorced since retiring and also got hit pretty hard in the '07-'08 downdraft, I'm still swimming and staying clear of the kelp beds.

Ha

 

[Dennis]

This Might Help or add to the confusion..From Jason Zweig-WSJ


"If you'd invested $10,000 in a 50/50 mix of stocks and bonds in December 1993, you'd have had $24,419 by December 1999. Then it was almost straight downhill; by September 2002, you would have had $19,240 left. Rebalancing would have yielded almost the same result. That's because bonds went up almost every single month over that period, while stocks kept crashing. After 2002 came another long upswing and then the recent brutal drop. How would this have affected your original $10,000 invested in 1993? If you rebalanced annually, by this February you still would have had $24,967 left. That is $4,000 more than if you had been 100% in stocks all along and $2,400 more than if you had invested your money 50/50 and never touched it after that."

If I had Rebalanced After every Bull Yr btwn 03-07? I would have Bought More Bonds and Less equities.. and earned 88% Less over all.. Funds/Sectors Run on a bull Run an average of 36 mos.. and it's best Not to Reduce them ( rebalance) until then.. I rebalanced in 06' mostly due to both " Market Sentiment" and Price Evaluations ( way over valued) in most Asset classes/Sectors.. from Reits to Int'l to All the Caps..

and am Not Rebalancing just yet and buying Buying More equities.. Just yet.. stocks/indexes are Low for a Reason and I let the Pro's tell me when they are worth more
the Only Rebalancing might just be due to your Age..starting with a 60/40 and increasing your bond Allocations by +1 to 2% every yr, depending on if your saving enough to begin with or not..

a 50/50 port Made 3% less than a 70/30 but a 70/30 had a 68% higher downside risk. Unless your Dealing with Mid to High 6-7 figures of savings? Is it really worth the risk? Vs just add another 10% to your savings to your 50/50 port to make that same Dollar value and you'll be able to Sleep better..


>I do a Comparision of Rebalance vs Not Rebalance every yr for past 11 yrs.. The difference btwn the 2? the Non Rebalanced Port made about 1% more apy ..
And I think Rebalancing so much is A Consipiricy by Wall Street.. to generate more Fee's..Just about everything those guys say is always to promote more $ for them in the Bottom line or Hidden somewhere..The gains made from Rebalancing was eaten up by fees as well.. Of course, It all depends on your Portfolio of Investments too..