Aug 23, 2011
If you think about the last few years, we’ve had stocks move to all-time highs in 2007, a big bust in global stocks in 2008 and a big move back up in 2009-2011 -- and then a sharp correction here again in Q3 2011.
Something like rebalancing a portfolio during these moves was positive for return overall using the simple assumption of using just stocks and bonds. However, as with nearly everything in portfolio management –there are caveats and nuances that surround every commonly accepted 'rule.'
For example, a 60-40 stock bond portfolio picked up good return by periodic re-balancing over past 7 years. It can be debated which is the best re-balancing rule --- but it should be pointed out that rebalancing, while moderately useful – is not a large source of value-add. ‘Allocate and rebalance’ seems to be the most commonly advocated strategy among firms who are just happy to earn fees off your money. What is often not openly disclosed is that rebalancing during a bull market (like re-balancing in the second half of 2009 -- away from stocks -- was in advance of large move up in 2010-11) hurts returns and offsets a portion of the value picked up when rebalancing works.
Now assume your allocation was 55% Stocks, 35% Bonds and 10% Precious Metals ---- you would actually be better off having never rebalanced. That is, the bull market in precious metals was more than the net benefit picked up by rebalancing other parts of portfolio (due partly to the cost of rebalancing in 2009 offset by the benefit of rebalancing in 2008). Maybe this is obvious – maybe it is not. But the point to remember is that rebalancing is something that can help somewhat over long-run --- though its total effect is likely overrated by most given what you read by financial firms that fail to acknowledge that this isn't a robust, universal strategy. The REAL value-add is in portfolio management is having exposure to market segment leaders (this year that means stocks and commodities in Q1 2011 and precious metals & bonds since then). note: We are of course assuming you are always still staying within your broader risk tolerance when we discuss pursuing market leaders.
Note that our basic Portfolio Allocation Backtest App has a drop-menu for rebalancing rules. To add some fun to this example, we use Berkshire Hathaway (BRKB) as the equity 60% -- and Bill Gross’s Total Return Mutual Fund (PTTRX) as the fixed-income 40%. We compare this to a 55% Stock Index (SPY), 35% Aggregate Bonds ( AGG) and 10% Gold (GLD). The rebalancing helps the Buffet-Gross mix --- but hurts the Stock-Bond-Gold allocation over this particular time period.