Does rebalancing daily yield the same outcome as rebalancing yearly?

[Markola]

Something I’ve wondered about, especially lately with the stock market drop and bond market rise: We have about 1/3 of our portfolio in 401k equivalents, all parked in 2020 target date funds. Those funds rebalance nightly, essentially, or at least very frequently, to stick closely to their asset allocations. Meanwhile, 2/3 of our portfolio is managed by our Vanguard advisor, who rebalances when the asset allocation exceeds a 10% band, e.g. if stock price swings throw the target AA off by more than 10%, he rebalances. We don’t have any extra trading costs for rebalancing, so expenses are not a factor.

My question is, does the math show that it will make any difference to our portfolio value in, say, 9 months or 15 months or 5 years, etc. if we remain committed to our asset allocation (50/50 in our case) over that period? Let’s assume there is no money entering or leaving the portfolio. Is there any advantage whatsoever to selling bonds (or cash) right now to buy “cheaper” stocks if at some point in the future we’re simply going to sell the appreciated stocks to buy cheaper bonds and return to our same stock/bonds (cash) asset allocation? It’s a hypothetical question, since we aren’t touching our assets regardless. I think the answer is obvious but I see people scrambling to “buy the dip”.

 

[mrfeh]

Is there any advantage whatsoever to selling bonds (or cash) right now to buy “cheaper” stocks if at some point in the future we’re simply going to sell the appreciated stocks to buy cheaper bonds and return to our same stock/bonds (cash) asset allocation?

I don't believe so. What you'll read over on bogleheads repeatedly: the purpose of rebalancing isn't to improve returns, but to control the risk of your portfolio.

I read a book a few years ago that looked at different rebalancing schemes (bands, time-based, etc), and the results were that the best way to rebalance (in regard to returns) was on a 4 year cycle. Of course, that was the past; who knows what will work best in the future.

We use bands.

 

[RunningBum]

I found a Bogleheads thread where someone studied this. https://www.bogleheads.org/forum/viewtopic.php?t=63189
It says that daily rebalancing outperformed monthly or yearly. It also says bands do even better. Frankly I didn't read that post too clearly to see how closely it followed your question.

Note that this post is from 2010. Things might have changed since then. Which would say..this isn't particularly useful.

My point is that testing theories with historical data can be almost random. I'm not talking about the 4% SWR, which looks at the data broadly, but trying to make sense out of daily or monthly swings is next to useless. It's almost like flipping a coin 100 times, then making predictions of heads vs. tails based on data like "when heads came up twice in a row, you were likely to get tails, but tails twice in a row was likely to give another tail".

 

[pb4uski]

Looks like more frequent rebalancing may be suboptimal. Since PV sata is only monthly there is no daily option.

Per Portfolio Visualizer... using VTSMX and VBMFX... from Jan 1993 to Feb 2019

Rebalancing frequency	60/40	40/60
None	8.15%	7.41%
Annual	8.15%	7.34%
Semi-annual	8.01%	7.20%
Quarterly	8.11%	7.30%
Monthly	8.01%	7.21%

 

[easysurfer]

Looks like more frequent rebalancing may be suboptimal. Since PV sata is only monthly there is no daily option.

Per Portfolio Visualizer... using VTSMX and VBMFX... from Jan 1993 to Feb 2019

Rebalancing frequency 60/40 40/60

None 8.15% 7.41%

Annual 8.15% 7.34%

Semi-annual 8.01% 7.20%

Quarterly 8.11% 7.30%

Monthly 8.01% 7.21%

According to the chart, looks like frequency of None ends up on top ... Interesting.

 

[RunningBum]

According to the chart, looks like frequency of None ends up on top ... Interesting.

It doesn't seem that surprising. Historically stocks do better than bonds, so letting stocks run could be best for your total return in a typical scenario, especially one that includes the extended bull market we've had. But you might not want the short to medium volatility.

I'm not looking to squeeze out the very best potential return on my assets. What I'm looking for is protection against an extended bad run, so I periodically rebalance to keep from being too heavy in stocks.

 

[easysurfer]

It doesn't seem that surprising. Historically stocks do better than bonds, so letting stocks run could be best for your total return in a typical scenario, especially one that includes the extended bull market we've had. But you might not want the short to medium volatility.

I'm not looking to squeeze out the very best potential return on my assets. What I'm looking for is protection against an extended bad run, so I periodically rebalance to keep from being too heavy in stocks.

+1.

I was getting the a similar conclusion in my mind.

 

[DenverGuy42]

Daily rebalancing can have a drastic effect on your tax situation if you are talking about taxable accounts (eg: not your 401k, just a regular investment account).

In order to rebalance, you have to sell something at a likely gain, in order to buy something else. You'll be taxed on the gain.

If you never rebalanced during the quarter, and at the end of the quarter you were within your 10% band still (maybe during the quarter you went in and out of it - doesn't matter), you will have no taxable events due to rebalancing.

But if you rebalanced every day, you would have had some taxable events since you got "out of band" every now and then.

We are currently trying to maintain our equity/bond balance by only mucking around with non-taxable accounts currently. If we get too stock heavy, we'll make our 401ks really bond heavy but keep the investment account more or less "as is".

About a year and half ago, we decided to become a little more conservative in our stock/bond mix. We accomplished that solely via 401k reallocation (we are in our early/mid 50s, won't be touching that money for a while). We got to our desired allocations without having any taxable events.

due to that change - the last week saw our regular investment account take a huge hit, while our 401ks just sort of sat there and said "what market crash".

on the bright side - when we look at a rebalance to increase stock holdings if the market stays down - we'll do much of that in our 401ks - again, as a non-taxable event. About 1/3 of our portfolio is wrapped up in the non-taxable accounts right now - like you. You might consider using them as your "all around portfolio rebalancing tool", instead of trying to keep each and every account perfectly balanced.

 

[COcheesehead]

It doesn't seem that surprising. Historically stocks do better than bonds, so letting stocks run could be best for your total return in a typical scenario, especially one that includes the extended bull market we've had. But you might not want the short to medium volatility.

I'm not looking to squeeze out the very best potential return on my assets. What I'm looking for is protection against an extended bad run, so I periodically rebalance to keep from being too heavy in stocks.

Google Kitces' rising equity glide path. He suggests starting with a low equity allocation and then letting it increase with age when in retirement. You might find his research of value.

 

[ziggy29]

Most of the analysis I've seen suggests that periodic rebalancing with "triggers" when your AA gets X% out of whack (or after a certain amount of time) works well to boost returns for two reasons:

(1) It periodically sells asset classes that have outperformed and are due for a regression to the mean;

(2) It takes advantage of the momentum theory, where in the short term a hot asset class tends to remain hot, and vice versa.

In other words, it takes a long term approach to stay ahead of mean-reversion while taking advantage of short term momentum. Daily rebalancing would seem to remove the "momentum" from the equation. At least as of a couple decades ago, Bernstein and other works seemed to suggest 12-18 months as the "sweet spot" for rebalancing frequency. More often than that, you lose some of the return from momentum; less frequently than that, the outperforming asset classes are more likely to go into reversion to the mean before you "sell high" in a rebalance.

 

[Midpack]

Most of the analysis I've seen suggests that periodic rebalancing with "triggers" when your AA gets X% out of whack (or after a certain amount of time) works well to boost returns for two reasons:

(1) It periodically sells asset classes that have outperformed and are due for a regression to the mean;

(2) It takes advantage of the momentum theory, where in the short term a hot asset class tends to remain hot, and vice versa.

In other words, it takes a long term approach to stay ahead of mean-reversion while taking advantage of short term momentum. Daily rebalancing would seem to remove the "momentum" from the equation. At least as of a couple decades ago, Bernstein and other works seemed to suggest 12-18 months as the "sweet spot" for rebalancing frequency. More often than that, you lose some of the return from momentum; less frequently than that, the outperforming asset classes are more likely to go into reversion to the mean before you "sell high" in a rebalance.

+1. Every study I've read says rebalancing doesn't make much difference in returns, and one frequency does NOT consistently beat another, e.g. daily vs monthly vs quarterly vs annually or longer. I'd pick a frequency, not daily for tax reasons, or better yet bands like 5/25 and stick with it knowing it will all average out over the long run. As others have said, rebalancing is to manage risk, not enhance returns. I only look at AA quarterly and rebalance if I'm outside 5/25 and only if I'm OK with the tax impact. I ignore (less than quarterly) up and down spikes as they're usually just that - spikes that will self correct. YMMV

 

[RunningBum]

Google Kitces' rising equity glide path. He suggests starting with a low equity allocation and then letting it increase with age when in retirement. You might find his research of value.

I've seen that, and have made my comments known about this in other threads. It has nothing to do with the OP's rebalancing question, so I'm not going to reiterate my opinion. If you want a rising glide path, you should do it intentionally, not by just letting your AA drift.

 

[Markola]

+1. Every study I've read says rebalancing doesn't make much difference in returns, and one frequency does NOT consistently beat another, e.g. daily vs monthly vs quarterly vs annually or longer. I'd pick a frequency, not daily for tax reasons, or better yet bands like 5/25 and stick with it knowing it will all average out over the long run. As others have said, rebalancing is to manage risk, not enhance returns. I only look at AA quarterly and rebalance if I'm outside 5/25 and only if I'm OK with the tax impact. I ignore (less than quarterly) up and down spikes as they're usually just that - spikes that will self correct. YMMV

Thanks for all the answers. I think Midpack’s says succinctly what I was looking for. There shouldn’t be fear of missing out this stock dip or whatever it is if one is committed to maintaining a set AA. If Others pointed out the tax implications but I wasn’t personally considering that since virtually all of our assets are tax advantaged.

 

[COcheesehead]

I've seen that, and have made my comments known about this in other threads. It has nothing to do with the OP's rebalancing question, so I'm not going to reiterate my opinion. If you want a rising glide path, you should do it intentionally, not by just letting your AA drift.

It achieves the same so I am not sure of your point.

 

[easysurfer]

+1. Every study I've read says rebalancing doesn't make much difference in returns, and one frequency does NOT consistently beat another, e.g. daily vs monthly vs quarterly vs annually or longer. I'd pick a frequency, not daily for tax reasons, or better yet bands like 5/25 and stick with it knowing it will all average out over the long run. As others have said, rebalancing is to manage risk, not enhance returns. I only look at AA quarterly and rebalance if I'm outside 5/25 and only if I'm OK with the tax impact. I ignore (less than quarterly) up and down spikes as they're usually just that - spikes that will self correct. YMMV

+1

Sticking the system and not having a knee jerk reaction is part of the achievement.

An analogy is in traffic zig zagging back and forth to constantly change lanes doesn't really accomplish much but waste gas . Have a system and stick with that.

 

[RunningBum]

It achieves the same so I am not sure of your point.

A rising glide path might mean, for example, that you retire at 30% equities, and increase that to 40% equities. You still have an AA, but it changes intentionally and you go with that no matter how the market as done.

Letting stocks run as I was stating it means you start with an initial AA but don't rebalance at all. It might mean your equities jump to 50%, or fall to 20%, depending on how stocks do. You no longer have an AA target to rebalance to, and it might achieve the same thing as the rising glide path, but it might not.

 

[rayvt]

I recently did a related backtest and posted the results in a discussion thread on another financial site.

The precis:
Results:
Initial value: $10,000
Initial AA: 80/20 S&P500 (incl div) / 1-Yr T-bill
1/1/1950 to 1/1/2016

Strategy End value: Max DD
no-rebalance buy-and-hold: $8,275,673 -48%
Monthly rebalance: $5,941,379 -39%

Dynamic AA: Stock allocation thresholds. Reduce/increase by 5 if exceeded.
88% & 72% $5,987,649 -44%
85% & 75% $6,097,597 -42%
90% & 70% $6,371,348 -44%


As is indicated in the current literature, the highest return is to start out with your chosen asset allocation and _never_ rebalance. However, this is the worst maximum drawdown.
Rebalancing every month results in the lowest return and the lowest drawdown.

 

[audreyh1]

The benefit of rebalancing is to invest across asset classes that aren't closely correlated and thus lower the overall volatility of your portfolio. The efficient frontier curves show how on average over many many years you can gain a large percentage of a 100% stocks gain, with considerably less volatility if you also have an asset allocation that includes bonds. Also, a minimum level of equity ownership (usually around 20%) normally outperforms a 100% bond portfolio with less volatility!!!

However, these efficient frontier curves vary considerably if you look at them decade by decade, so it's good to understand that the situation varies from depending on the period examined.

Most of the models use annual rebalancing at the start of the year. I'm not sure there have been any rigorous studies of trigger-based rebalancing models. But there have been studies of different rebalancing periods.

In order to benefit from rebalancing, you need to give some time for the different asset classes to diverge. I remember reading a paper quite a while back that the optimum rebalancing interval was 18 months for a taxable account, and maybe it was 1 year for a tax-deferred account. Rebalancing less often in the taxable account helped reduce the tax drag of rebalancing.

 

[Markola]

Thanks Audrey. From this I take it that the daily or so rebalancing within our tax-advantaged target dates funds is slightly mathematically suboptimal to one year rebalancing. However, I’m going to guess that it’s not a difference that’s worth losing sleep over. It’s another interesting investing paradox that doing something daily ends a portfolio up in about the same place as doing that thing annually or every 18 months.

 

[audreyh1]

I don’t remember the differences. I don’t think the paper tested daily rebalancing. It might have tested quarterly. I don’t remember how “slight” the difference was - it was perhaps small but not tiny.

Personally it encouraged me to rebalance less often rather than more. But I do have triggers for extreme cases - again favoring less often rather than more because I made the bands quite wide after the 2008 fiasco.