Rebalancing Gives No Instant Gratification

Part of the theory behind maintaining a fixed percentage allocation of your portfolio to different asset classes, like stocks and bonds, is that when markets are volatile, you can increase returns by rebalancing.  Unfortunately, there is no immediate return from rebalancing.

To show that rebalancing has created a profit, you need to take into account not just your most recent rebalancing trade, but also the last time you rebalanced in the other direction.  If you do the calculation, it will show whether the second to last rebalancing trade produced a profit, but the most recent one won't show a profit until the next time you rebalance in the other direction.

This situation creates a problem of a delay from effort to reward.  We're much better at doing things that give immediate gratification.

Comments

  1. PotatoAugust 11, 2011 at 12:46 AM

    You have just given me a brilliant idea for my future investor coaching service: rebalance and get a cookie.

    ReplyDelete
  2. Mark WolfingerAugust 11, 2011 at 9:05 AM

    Anyone who believes in re-balancing, must do it.

    Being too cautious defeats the purpose. Timing your trades is counter to the basic idea of re-balancing.

    ReplyDelete
  3. PatrickAugust 11, 2011 at 10:01 AM

    Well, rebalancing is not about boosting returns. It's about managing risk. Maybe you can get a warm fuzzy from seeing that your asset allocation has protected you from recent stock market volatility, and you can feel good about restoring your carefully-chosen asset allocation by rebalancing?

    Ok, I'm grasping at straws here. I think rebalancing is inherently an unemotional activity.

    ReplyDelete
  4. Michael JamesAugust 11, 2011 at 3:00 PM

    @Potato: Great idea. Can I have a steak instead?

    @Mark: Agreed. Unfortunately, many investors who have a plan that involves rebalancing don't do it during volatile periods for stocks.

    @Patrick: I agree that rebalancing is primarily for limiting risk. However, it does have the side benefit of a boost to returns during volatile periods where asset classes don't have high correlation. Too few investors are able to bring themselves to restore their percentage allocation to stocks when stock prices fall. They tend to sit tight and wait for things to calm down, or worse, sell stocks when they're down.

    ReplyDelete

Post a Comment

Popular posts from this blog

Short Takes: InvestorLine’s HISAs, 24-Hour Trading, and more

I recently moved some cash into BMO InvestorLine’s high-interest savings accounts (HISAs) that are structured as mutual funds.  Their designations are BMT104, BMT109, and BMT114, and they purportedly pay 4.35% annual interest (which they can change whenever they like).  However, the way they report the monthly interest payments is so baffling that I wasn’t able to sort it out in my first 15 minutes of trying.  A further complication is the following text in the HISA description: “The Bank may pay, monthly or quarterly, compensation to your Dealer at an annual rate of up to 0.25% of the daily closing balance in the BMO HISA.”  I couldn’t find any evidence of such a charge, but I haven’t been invested for a full quarter, and I can’t yet say that such a charge isn’t buried somehow in the confusing reporting.  I have more digging to do before I can recommend these HISAs. Here are some short takes and some weekend reading: Preet Banerjee explains the dangers of Robi...
Read more

My Asset Allocation

I’ve resisted discussing my asset allocation for some time, but now is finally the time to describe it and the reasons behind it. I’m not holding it out as a model portfolio; I believe it’s suitable for me and not necessarily anyone else. With that warning, enjoy the discussion and feel free to ask questions or take some pot-shots. The main reason why I haven’t discussed my asset allocation in detail before now is that I don’t want readers to treat it like a model portfolio and follow it blindly. Everyone’s situation is different. The need for variation in asset allocation from one investor to the next usually isn’t huge, but there is no one-size-fits-all portfolio. A secondary reason for keeping my asset allocation to myself is that I can’t be sure I’ll never change it. For example, I recently made the minor change of switching from an ETF of small-cap stocks to an ETF of small-cap value stocks . I don’t have any plans to change my current allocation, but I may think differe...
Read more

What to Do About Crazy Stock Valuations

Image
The last time I had to put a lot of effort into thinking about my finances was back when I retired in mid-2017.  I had ideas of how to manage my money after retirement, but it wasn’t until a couple of years had gone by that I felt confident that my long-term plans would work for me.  I had my portfolio on autopilot, and my investing spreadsheet would email me if I needed to take some action. I was fortunate that I happened to retire into a huge bull market.  I got the upside of sequence-of-returns risk.  The downside risk is that stocks will plummet during your early retirement years, and your regular spending will dig deep into your portfolio.  Happily for me, I got the opposite result.  My family’s spending barely made a dent in the relentless rise of the stock market. However, stock prices have become crazy, particularly in the U.S.  One measure of stock priciness is Robert Shiller’s Cyclically Adjusted Price-Earnings (CAPE) ratio .  In the U.S...
Read more

Archive

Show more