Recently, the Stingy Investor pointed to an article whose title caught my eye: The Academic Failure to Understand Rebalancing , written by mathematician and economist Michael Edesess.  He claims that academics get portfolio rebalancing all wrong, and that there’s more money to be made by not rebalancing.  Fortunately, his arguments are clear enough that it’s easy to see where his reasoning goes wrong. Edesess’ argument Edesess makes his case against portfolio rebalancing based on a simple hypothetical investment: either your money doubles or gets cut in half based on a coin flip.  If you let a dollar ride through 20 iterations of this investment, it could get cut in half as many as 20 times, or it could double as many as 20 times.  If you get exactly 10 heads and 10 tails, the doublings and halvings cancel and you’ll be left with just your original dollar. The optimum way to use this investment based on the mathematics behind rebalancing and the Kelly criterion is t...

A popular type of investing is factor investing.  This means seeking out companies with attributes that performed strongly in the past, such as small caps (low total market capitalization) and value stocks (low price-to-earnings ratios).  I can’t say I’ve studied this area extensively, but one observation I’ve made is that these factors always seem to disappoint investors after they become popular. It’s hard to figure out exactly why factors seem to disappoint, but I’m not inclined to pay the extra costs to pursue factor investing beyond my current allocation to stocks that are both small caps and value stocks.  Several years ago this combination was my best guess of the factor stocks most likely to outperform.  I’m still not inclined to try others. Here is how I think about whether someone is ready for DIY investing: What You Need to Know Before Investing in All-In-One ETFs Here are some short takes and some weekend reading: Ben Felix explains why dividends are irr...

I get a lot of questions from family and friends about investing.  In most cases, these people see the investment world as dark and scary; no matter what advice they get, they’re likely to ask “Is it safe?”  They are looking for an easy and safe way to invest their money.  These people are often easy targets for high-cost, zero-advice financial companies with their own sales force (called advisors), such as the big banks and certain large companies with offices in many strip malls.  An advisor just has to tell these potential clients that everything will be alright and they’ll be relieved to hand their money over. A subset of inexperienced investors could properly handle investing in an all-in-one Exchange-Traded Fund (ETF) if they learned a few basic things.  This article is my attempt to put these things together in one place. Index Investing Most people have heard of one or more of the Dow, S&P 500, or the TSX.  These are called indexes.  They a...

I was reminded recently of the paper The Misguided Beliefs of Financial Advisors whose abstract begins “A common view of retail finance is that conflicts of interest contribute to the high cost of advice. Within a large sample of Canadian financial advisors and their clients, however, we show that advisors typically invest personally just as they advise their clients.” I didn’t find this surprising.  Retail financial advisors are like workers in a burger chain.  I wouldn’t expect these advisors to understand the conflicts of interest in their work any more than I’d expect workers in a burger chain to understand the methods the chains use to draw customers into eating large amounts of unhealthy food.  It’s hardly surprising that so many advisors understand little about investing well, and that they run their own portfolios poorly. However, this doesn’t mean the conflicts of interest don’t exist.  It is those who run organizations that employ, train, and design pay st...

Investors often seek to maintain fixed percentage allocations to the various components of their portfolios.  This can be as simple as just choosing allocations to stocks and bonds, or it can include target percentages for domestic and foreign stocks and many other sub-categories of investments.  Portfolio components will drift away from their target percentages over time, requiring investors to perform trades to rebalance back to the target percentages.  A natural question is whether rebalancing produces profits, and if so, how much. A long-time reader, Dan, made the following request: I have a topic request. On the subject of portfolio rebalancing, I have read your many posts and whitepaper [see Calculating My Retirement Glidepath ]. I have actually implemented something similar (but not exactly the same) myself.  I saw in one blog post, cannot find where, that you said something to the effect of “my rebalancing trades last year produced a profit”. My topic request...