Jump to content
tony

New Research Casts Doubt On Rebalancing

Recommended Posts

And to that end, portfolio rebalancing is recommended by virtually every ETF provider, advisor and planner. According to Vanguard, rebalancing can provide 35 basis points of alpha a year. BlackRock rebalances its model portfolios every quarter. While most planners and advisors actively militate for rebalancing.

But does rebalancing add value for investors? Perhaps not, an important new research paper has found.

http://www.etfstream.com/news/6074_new-research-casts-doubt-on-benefits-of-rebalancing

Share this post


Link to post
Share on other sites

This guy needed a published article for his editor. 

Read this gobbledygook: "While buy-and-hold portfolios tended to be more unpredictable, they were much more likely to produce returns greater than 6% a year."

and this: "While the buy-and-hold strategy has a greater standard deviation of ending wealth than the rebalancing strategy, that greater standard deviation is almost entirely due to an increase in upside opportunity rather than an increase in downside risk,” it said.

Huh? Of course, unbalanced portfolios are MORE UNPREDICTABLE that's why we rebalance. And of course, an increase in SD produces higher returns because of increased risk. 

Look folks, all research draws on past data and that's fine. But the subtle message of this article is to get people to stop rebalancing. All we have is the future, and it is totally uncertain, unpredictable and unknown. Yes, this research says that rebalancing underperformed buy and hold. So what am I supposed to do? Not rebalance? 

The only thing that I trust in the financial industry is that the worldwide markets will increase in value over time and I will keep rebalancing as needed. This is hype to get you to change your plan. 

Ignore this crap. 

Share this post


Link to post
Share on other sites

For any readers confused by all the technical terms:

1. People will tell you rebalancing between stocks and bonds allows you to buy stocks at their low points and enjoy larger returns. On top of misunderstanding the purpose of rebalancing, those folks are also incorrect about generating larger returns.

2. The purpose of rebalancing is to keep the riskiness of your portfolio in line with your risk tolerance.

3. If you don’t rebalance then your portfolio will become more stock heavy over time because stocks increase in value more quickly than bonds. As a result your portfolio generates larger returns because you’ve taken on more risk.

...so this article is telling us what we already know, stocks have a higher expected return and more volatility than bonds do. 

Share this post


Link to post
Share on other sites

^ Agreed. I don't expect rebalancing to necessarily improve performance in the short term.  I expect it to keep me at my desired risk tolerance which hopefully works out well long term.

 

Share this post


Link to post
Share on other sites
15 minutes ago, sschullo said:

Where is the research that reports that rebalancing does not increase returns? 

I’m currently preoccupied with another task right now, but Google may turn up something. The research referenced in the article linked in this thread concluded that rebalancing lowered returns.

I encourage everybody to fact check everything. However, I take this conclusion at face value because it seems so “obvious” to me. Stocks rise faster than bonds, which means most rebalancing events will reduce your stock allocation, which reduces expected future returns.

Now for some asset allocations, it would not surprise me if rebalancing increases “risk adjusted returns” and for folks who already prefer those allocations, that is an awesome free lunch. However, even in the cases when/if risk adjusted returns are increased, I still expect total returns to be reduced.

...again fact check me, I’m basically 100% stock so I have no reason to be an expert on this issue. 

Share this post


Link to post
Share on other sites

I see what you are saying Ed. You made it sound like rebalancing was a negative strategy. 

However, I think we are also confusing rebalancing with the stock-bond split. The stock-bond split, of course, will lower returns because any bond allocation reduces return. That should not be compared with rebalancing. Slowly increase bonds over time reduces risk and of course, it will reduce returns, but it will also decrease downsize risk too. That's the point with the stock-bond split.

Rebalancing is a very good antidote for the disastrous habit of millions of investors that sell low (during a crash) and buy high (when the market is soaring). It is about the only time investors can do the prudent thing, sell high and buy low. That is a great idea! Rebalancing can also involve equity asset classes, small, mid and large cap for example. Historically small cap outperformed mid and large cap. So for somebody with 100% stock portfolio, rebalancing can be used too. 

I wonder what the research says about rebalancing between equities. Yes, we can all agree that a 100% stock portfolio will outperform a 100% bond portfolio. That is another topic. That's why my portfolio will almost always underperform everybody else who posts their returns.

You are correct that rebalancing reduces return, but the good news it also reduces risk. And as we get older, if we need the money when we don't work for income then reducing risk is a good thing. However, some teachers have high enough pensions they can keep their equity exposure high during retirement. However, buying low and selling high I would think will increase returns. 

Share this post


Link to post
Share on other sites
2 hours ago, sschullo said:

You made it sound like rebalancing was a negative strategy.

Rebalancing is absolutely the right thing to do. I want to be very clear about that.

2 hours ago, sschullo said:

However, I think we are also confusing rebalancing with the stock-bond split.

The two are related. Rebalancing returns you to your desired stock-bond split.

2 hours ago, sschullo said:

Rebalancing is a very good antidote for the disastrous habit of millions of investors that sell low (during a crash) and buy high (when the market is soaring). It is about the only time investors can do the prudent thing, sell high and buy low.

I might agree with the first part, but there is some nuance worth noting.

I argue that it isn’t possible to develop a strategy that allows you to buy low and sell high. Doing so would require short term predictive power and I argue that none of us have that.

The only antidote to buying high and selling low is to embrace long term investing and try to adopt Buffett’s ideal holding period, which is forever.

Some folks require a less risky portfolio to prevent them from making foolish decisions in a crash. To the extent that rebalancing returns an investor’s portfolio to their personal risk tolerance, rebalancing will help people avoid market timing and panic-selling and thus increase returns relative to the disastrous decisions they might have made.

However, rebalancing does not help somebody buy low and sell high and it decreases expected returns if you’re rebalancing between stocks and bonds.

2 hours ago, sschullo said:

rebalancing reduces return, but the good news it also reduces risk.

This is exactly the correct way to view rebalancing.

2 hours ago, sschullo said:

as we get older, if we need the money when we don't work for income then reducing risk is a good thing.

My views on this are more complicated.

Let’s assume somebody is a cold blooded machine and they’ll never panic-sell in a crash. If that person is going to rely on a conservative portfolio to sustain them then they’ll require a much larger portfolio than they otherwise would have. That means they’ll have to work longer or accept a lower standard of living. I believe that would be a terrible decision for this hypothetical person.

Let’s assume somebody is prone to panic-selling. The damage that person would do with a risky portfolio is orders of magnitude greater than the damage that a conservative portfolio does to their returns and the additional required years of working. Bonds are awesome for this person.

In my view, bonds are purely a hedge against behavioral issues. An insurance policy against you burning your own house down. And bonds also buy somebody peace of mind if they’re the type to get anxious with volatility.

Share this post


Link to post
Share on other sites

Ed,

What you say is what a financial adviser might say to clients and get them a wee bit confused. I understand it this way, and it has worked for me for years now: Bonds reduce equity risk, and its a core feature in constructing a world-wide equity diversified portfolio. Rebalancing is the primary management tool for DIYers going forward, a combination of continuing to reduce risk and volatility as we get older, but also to sell high and buy low, as I have mentioned before. In the perfect world, that's how it works. But the portfolio must include the core asset classes, all indexed that covers the entire world equities and bonds, although international bonds are not necessary, I have them. I love diversification. 

But in our imperfect world, people's emotions get in the way because it takes a lot of nerve to sell one's darlings and purchase the losing asset classes, especially between equity asset classes. Bonds do not grow a portfolio, they are for preserving it as we get older. 

Share this post


Link to post
Share on other sites

Rebalancing does more harm than good according to this article. I haven't rebalanced in years. I would never rebalance monthly quarterly or even yearly. But part of my portfolio rebalances itself and other parts don't. I will instinctively know when changes are needed and will act accordingly, otherwise I just let it go.John Bogles  doesn't didn't rebalance either. I think having taxable accounts complicates things. But  I do believe in dollar cost averaging new money to reach a certain portfolio  balance. . You guys can continue your interesting discussion . I'm enjoying it but I agree with this article. Just call my insertion here  a brief interlude.

https://money.usnews.com/investing/buy-and-hold-strategy/articles/2018-05-08/is-portfolio-rebalancing-necessary

Share this post


Link to post
Share on other sites

My taxable account represents more than three quarters of my portfolio and keeping my asset allocation in line has been a breeze. I’ve never had to sell anything in my taxable account for the purposes of rebalancing.

Using new money to purchase what I have too little of has been the main reason I’ve never had to sell and buy to rebalance.

When my taxable account has too much of something, I’ll turn off dividend reinvestment and use that income to buy what I have too little of.

When my portfolio becomes too large for these moderate adjustments to be 100% effective, I can do all of my rebalancing in my tax advantaged accounts (where unlike a taxable account selling doesn’t produce a tax bill). As a result neither my taxable account or my tax advantaged accounts will meet my asset allocation on their own, but collectively they will. That’s one of the reasons people shouldn’t think of each account as a mini-standalone portfolio, think of your portfolio as the cumulative result of each account you have. 

Share this post


Link to post
Share on other sites

Bogleheads WIKI on rebalancing: https://www.bogleheads.org/wiki/Rebalancing 

I just rebalanced in October when my equity allocation was 5% above my plan, and I am very happy I did before the stock decline at the end of 2018.

As I have said before, it is one strategy that gets me to sell the high flyers (stocks) and buy low (bonds). Bond prices are down, BTW. 

Share this post


Link to post
Share on other sites

Rebalancing between stocks and bonds decreases expected returns. When people say it allows them to sell high and buy low, they are incorrectly perpetuating a falsehood that rebalancing increases returns. It does not.

Share this post


Link to post
Share on other sites

We rebalance to 40% stocks/60% bonds, using 5% bands. It can be painful to prune a winner, but that is the plan we’ve decided to follow. I agree with Ed that rebalancing doesn’t increase a portfolio’s rate of return, but as he and others note it does reduce risk to a desired level. It does beat selling out at or near the bottom and buying back after a rise. In retirement, with no additional contributions to the portfolio, we need to rebalance to keep our asset allocation under control. 

Vanguard produced a white paper on rebalancing in 2010. It points out that frequent rebalancing has a cost. “If an investor’s portfolio can potentially hold either stocks or bonds, and the sole objective is to maximize return regardless of risk, then the investor should select a 100% equity portfolio.” https://www.vanguard.com/pdf/icrpr.pdf

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now

×