Don't waste your money rebalancing

[REWahoo]

According to Paul Farrell (http://tinyurl.com/ckwa2), rebalancing your portfolio is a plot hatched by brokerage houses...


Don't waste your money rebalancing
Focus on initial asset allocations and regular savings
By Paul B. Farrell, MarketWatch
Last Update: 6:31 PM ET July 3, 2005


ARROYO GRANDE, Calif. (MarketWatch) -- You never have to rebalance your portfolio. The rebalancing imperative is a silly myth invented by brokers.

If your portfolio's well-balanced to begin with, rebalancing is a waste of money. Get your initial allocations right. Save regularly and simply add new money to keep your portfolio in line with your ideal.

<snip>

Here are four ways to stay on the right track:

1. Balanced start. Start with an ideal portfolio whose asset allocations accurately reflect your lifestyle and minimize risk over the long-term.
2. Pick quality. You need 10 funds at most for a well-diversified, balanced portfolio. Low-cost index funds work best. Buy with the intention of never selling.
3. Regular savings. Most unbiased advisers say rebalancing once a year is enough. Others suggest rebalancing when allocations deviate 5% to 10% off the ideal. I say erase the word rebalancing from your vocabulary. Begin with a balanced portfolio and simply add regular savings to keep your portfolio in balance. Period.
4. Discipline. Stop chasing bulls and hiding from bears. Don't listen to your broker and the talking heads on cable for tips. If you're buying and selling securities on a regular basis without a balanced portfolio to begin with, rebalancing is impossible. You're simply trying to justify after the fact that all you have is a random collection of assets that don't work as a portfolio. And you're wasting money.

 

[unclemick]

To put it buntly

Are you in accumulation or distribution?  Do you know why you own what you own? If you are a POGO - we have met the enemy and we is them - buy the appropriate single fund - like one of the Vanguard Target Retirement Series or at least benchmark it and try to beat it - until you get your hormones under control.

Rebalancing - if you slice and dice - read a lot - not the dumbed down Four Pillars - but his earlier book on Asset allocation - perhaps some Gibson? Expect to underperform De Gaul.

One more before sugar doughnut(BSD) thing - ask yourself this - when you read something in the financial media - how much does this guy's job depend on publish or perish - if he doesn't say something new and cute.

Bogle is the only one I know - who hammers away on the same message - over and over and over and over and over and etc., etc. Bernstein? - maybe ok - but he may be slipping over to the 'dark side'? But I did enjoy Birth of Plenty. Lets hope the media doesn't suck him up and throw him off track - keep your fingers crossed.

 

[Cut-Throat]

You never have to rebalance your portfolio. The rebalancing imperative is a silly myth invented by brokers.

If your portfolio's well-balanced to begin with, rebalancing is a waste of money. Get your initial allocations right. Save regularly and simply add new money to keep your portfolio in line with your ideal.

I read the article in yesterday's paper. The above statement is misleading as he is describing re-balancing, not by selling but by buying. For those in the withdrawal phase, this is not possible.

The article went on to say that re-balancing yearly is effective, especially if you are not paying costs to do so.

 

[preben]

Yeah in distribution where should those new savings come from? In accumulation is is pure logic that the new money goes to re-balance. And then he recommends re-balancing anyway?
Oh well - I will re-balance. Call my a wild, crazy puppy!

 

[unclemick]

Well - to repeat myself - as much as I pooh pooh - slice and dice - if I were a "Perpetual Tourist" , ex- pat with currency concerns long term - I would seriously consider muti - asset/value tilt/ rebalancing to a preset asset allowcation periodically - WITH a eye on divs/interest as a backstopper.

As a myopic American with no oversea's travel plans - still kinda in the Romulan Neutral Zone as to the classic pie chart balanced index versus slice and dice in some form.

Remember - I do cheat - 10% REIT Index to go with my 75% Lifestrategy mod - a quasi 60/40 computer rebalancing cat.

Theoretical purity is NOT one of my strongpoints!

Heh, heh.

 

[preben]

I agree Unclemick!

 

[cute fuzzy bunny]

I sort of rebalance through buying without earned income by redirecting dividend streams from one fund to buy shares of another that I think is a better value or that I want to own more of.

 

[grumpy]

over the years I have found that Paul Farrell is master at mis-stating the obvious.

Grumpy

 

[maddythebeagle]

"I sort of rebalance through buying without earned income by redirecting dividend streams from one fund to buy shares of another that I think is a better value or that I want to own more of"

That is a good point. I also think a lot 401k type plans dont charge to move from one fund to another. I guess that I only see this as an issue is in a ira or investment account in a brokerage and this might only be a sliver of the whole port. If you have dividend reinvestment plans and want so much in growth stocks vs. reits or whatever, you could take the dividends in cash and send in optional cash payments to the plans that you want.

 

[preben]

If any surplus left after my withdrawals of dividends+interest I will of course re-invest them in whatever asset class have performed the worst and therefore is out of balance - I just have a hard time seeing that this article had any new insights about re-balancing... :

I am in the distribution phase and am currently contemplating how to do my re-balancing. Once every 2-3 years seem to give the historical best returns according to some studies (due to momemtum), most advisers say once per year is fine. But I wonder whether the rules change slightly in the distribution phase. Would re-balancing based on % or $ out of whack help in reducing volatility of the FIRE portfolio?
And would it be worth giving up a bit of return for less volatility? (for insurance).

Cheers!

 

[cute fuzzy bunny]

"I sort of rebalance through buying without earned income by redirecting dividend streams from one fund to buy shares of another that I think is a better value or that I want to own more of"

That is a good point. I also think a lot 401k type plans dont charge to move from one fund to another. I guess that I only see this as an issue is in a ira or investment account in a brokerage and this might only be a sliver of the whole port. If you have dividend reinvestment plans and want so much in growth stocks vs. reits or whatever, you could take the dividends in cash and send in optional cash payments to the plans that you want.

All I do is set the reinvestment option for dividends to be 'buy another fund' at vanguard, and pick the fund I want to buy. I have my IRA's REIT fund dividends buying small cap value. Cap gains reinvested in the reit fund. That way I bleed the ~5% dividend from the reit fund and DCA small cap value. For the next 20 years or so until I tap the IRA.

You may not be able to do this as automatically with a 401k or other fund shop though.

 

[Nords]

We have a lot lower dividend yield and we spend it all. At the end of the year we sell a year's worth of expenses from the biggest winner, put some of it in an IRA, and stop worrying about it.

 

[fufund]

Paul's article is not particularly well written, but in all fairness his target audience is the unsophisticated investor ( whom wall street rapes and pillages on a daily basis).

His valid points (paraphrased)are:

1) don't churn your portfolio
2) you can rebalance in the saving cycle (duh!)
3) don't chase performance, pick a plan (allocation) and stick with it

Their are, however, dangerous gaps in logic for those that read "info-lite" articles literally.

To whit.....

a) The punch line of the article is "don't rebalance" when in fact he is recommending rebalancing in the accumlation stage

b) "In the 1990s the Schwab Center for Investment Research compared annual rebalancing with rebalancing every three years. The difference in long-term returns was minor. You gained less than one percentage point by rebalancing annually."

His data is 1 yr vs three year re-balancing instead of rebalancing vs. not rebalancing.... apples and oranges

c) the above quote trivualizes a one percent difference when we all know, over time, how big this difference really is ( the reason for selecting low cost funds like Vanguard,etc)

d) and last, but not least, if someone where to NEVER rebalance (in accumulation or distribution phase) they miss a golden opportunity to both reduce risk AND maximize returns at the same time.

as is true with all articles of this nature..... "let the buyer beware"

In my own situation, I have "back tested" (standard disclaimer: the past does not mean the future will be the same) my own asset allocation (mostly Vanguard equity indexes and bond funds) for periods of 1, 1.5,2,3, and 5 years. I have found that a 2 year rebalance period seems about optimal. Although it is dangerous to infer cause, my guess is that the reason a 2 year re-balance "back tests" out a little better than a one year re-balance, is that asset categories tend to have a little momentum year over year.

I know that for those that crave action, rebalancing every two years hardly fits the bill. But as they say, investing is suppossed to be boring (wereas speculating is exciting and/or terrifying, depending on your perspective) And, for what it's worth, I am 47 and in the distribution phase

fufund

 

[preben]

Fufunds; interesting...
I will try to do a similar back test for fun too on my portfolio. Cheers!

 

[wabmester]

d) and last, but not least, if someone where to NEVER rebalance (in accumulation or distribution phase) they miss a golden  opportunity to both reduce risk AND maximize returns at the same time.

Can you point me to any long-term data that support that statement?   My own feeling is that the benefits of rebalancing are purely psychological.    Your chances are about 50/50 of it helping/hurting your returns and volatility.

However, I would like to show you something interesting:

An interesting thing happened in the last 20 years: bond prices went up (as yields went down) and stock prices went up for most of that period as well.    That basically meant that you couldn't lose by rebalancing between stocks and bonds.    Both assets went up for the last 20 years.

Personally, I expect the odds of that happening for the next 20 years to be close to zero.    So as far as rebalancing increasing returns and reducing volatility, caveat emptor.

 

[unclemick]

Brings back memories of the fun period of 1966 - 1982.

But - I was working in those days - heh, heh, heh.

 

[preben]

I believe there are studies out there showing a re-balancing bonus of about 1% but I would have to search for them + not sure whether caused by your point about bond returns the last 20 years.
Anyway; the re-balancing bonus should not only come from bonds+stocks but also from other asset classes such as metals. commodities, reits Etc.
Cheers!

 

[wabmester]

I believe there are studies out there showing a re-balancing bonus of about 1% ....

Oh, I'm sure there are. But my point is that the "bonus" is completely dependent upon the timing, frequency, and investment climate at the time. I can think of no fundamental reason that "automatic" rebalancing should produce any bonus over the very long term, and if there is no underlying theory that justifies such a bonus, I consider it a statistical fluke.

I guess I find it amusing that the same people who denegrate market timing also tout the benefits of rebalancing. There is no difference -- rebalancing is just one very simple-minded attempt at buying low and selling high.

 

[preben]

You might be right but could also be momentum and reversion to the mean being factors creating the re-balancing bonus? Cheers!

 

[cute fuzzy bunny]

Wab - maybe i'm dense (shaddup) but I thought the core premise behind rebalancing was taking away from asset classes that had 'run ahead' and putting the excess into the laggards.

It doesnt work if you have asset classes that 'never stop' or those that 'never rise' (aka energy/reits and japan for the recent term). But like Ben I thought I had seen plenty of data that showed a rebalance every 2 years helped.

As soon as I manage to own a holding in anything for 2 years or more, I'll let you know.

 

[Nords]

It's not how often, it's how much.

Wab - maybe i'm dense (shaddup) but I thought the core premise behind rebalancing was taking away from asset classes that had 'run ahead' and putting the excess into the laggards.

It doesnt work if you have asset classes that 'never stop' or those that 'never rise' (aka energy/reits and japan for the recent term).  But like Ben I thought I had seen plenty of data that showed a rebalance every 2 years helped.

As soon as I manage to own a holding in anything for 2 years or more, I'll let you know.

I've been waiting for the "how often" debate to settle to a concensus, but it seems to be based on historical data. Not that we have anything better, but two years is a lot more tolerable than monthly.

However I thought it was based on asset allocation instead of time intervals. I wouldn't rebalance until asset allocation had drifted far enough away from the original plan to affect one's sleep. So if you're drawing your living expenses from the asset that's had the strongest runup, that tends to hold the AA near its original numbers.

Personally we've been drawing down Tweedy, Browne Global Value (TBGVX), our biggest % holding, and it's still going up faster than we're chewing into it. So I could see harvesting some of that if it rises to over 40% of our AA and putting it into a small-cap value ETF (or the proposed micro-cap value ETF). We've been letting our Dow Dividend ETF rise on its own without touching it-- in another 20 years or so I could turn into an income investor.

I don't know if I'm capable of selling Berkshire Hathaway shares. I have this irritating feeling that its breakup value is worth far more than its share price...

 

[cute fuzzy bunny]

in another 20 years or so I could turn into an income investor.

We will all bow our heads and observe a moment of silence...

 

[wabmester]

Re: It's not how often, it's how much.

I've been waiting for the "how often" debate to settle to a concensus, but it seems to be based on historical data.  Not that we have anything better, but two years is a lot more tolerable than monthly.

The "how often" debate will never stop because there is no right answer -- selling one asset and buying another doesn't "win" on any special periodic basis. Winning or losing using that strategy is pure luck. My portfolio would be *very* heavily weighted towards Japanese stocks if I followed an automatic rebalancing strategy for the past 20 years.

 

[Patrick]

Re: It's not how often, it's how much.

My portfolio would be *very* heavily weighted towards Japanese stocks if I followed an automatic rebalancing strategy for the past 20 years.

Would that be a bad thing?



Patrick

 

[wabmester]

Re: It's not how often, it's how much.

Would that be a bad thing?

Yeah, it would have been pretty hard to retire early with a large exposure to an asset that declined for about 12 years straight.