(PUB) Investing 2016

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12 • Fund Family Shareholder Association
IT MAY BE one of the most common
questions investors ask every year as
December turns to January. Should I
rebalance or not?
The dramatic start to 2016, with 500
Index dropping 5.0% and Total Bond
Market Index gaining 1.4%, is an
awfully good time to address this ques-
tion. If, at the start of the year, your port-
folio was evenly divided between these
two funds, some rebalancing strategies
would have dictated that you sell some
of your bonds to buy more stocks at the
end of January. Could you have done
that, and would you have done that?
You just put half your money to work
in stocks, only to see it fall 5.0%, and
now are supposed to buy more. Easier
said than done. And that’s one of the
three lessons I hope you’ll take away
from this discussion of rebalancing:
It’s easy to dictate rules for investing
in backtests, but much more difficult to
execute them in real life.
The other two takeaways? First,
rebalancing is all about managing risk,
not improving returns—in fact, after
costs and taxes, rebalancing almost cer-
tainly reduces your returns over time.
Second, you may not need or want to
rebalance like clockwork in the first
place, but if you do, follow your strat-
egy to the letter.
I’ll come back to each of those points
throughout this article, but let’s start at
the beginning. Rebalancing is a strategy
where you determine an initial, desired
allocation for your portfolio—say 50%
stocks and 50% bonds—and then, over
time, trade your portfolio back to that
starting mix. To use the standard exam-
ple, I looked at a 50/50 mix of stock
and bond funds in a portfolio, using 500
Index and Total Bond Market Index as
my proxies going all the way back to
Total Bond Market Index’s inception in
December 1986. (Total Stock Market
didn’t see the light of day until April
1992, hence my use of 500 Index.) The
chart above shows how that portfolio’s
allocations would have changed over
time if you never rebalanced. Stocks
tend to outperform bonds, and hence
500 Index came to represent a larger
and larger piece of the portfolio over
time. For instance, at the end of 2015,
that original 50/50 portfolio would have
morphed into one with 73% of its assets
in stocks.
Some investors, having seen the
stock market outperform the bond mar-
ket between 1986 and 2015 might say,
“Well, I’m glad I have more money
in stocks today.” But that defeats the
purpose of rebalancing, which is meant
to support the original decision to have
one’s allocation be (in this case) a
50/50 mix, not a 73/27 mix.
The Vanguard Way
Vanguard loves rebalancing. It is one
of the “disciplined investment princi-
ples” that its Personal Advisor Service
follows in managing client portfolios.
Vanguard’s website regularly features
articles and suggestions about the ben-
efits that rebalancing provides (such as
the moves you can make for yourself,
or the regular rebalancing that occurs
within its funds-of-funds as cash flows
in and out).
Vanguard, of course, is not the only
voice on rebalancing. The other robo-
advisers, Betterment and Wealthfront,
claim that, for instance, rebalancing
can add 0.4% to your performance
per year (though I think there’s a lot
of cherry-picking that goes along with
these studies).
The question of when, why and how
you should rebalance your portfolio also
garners plenty of media attention on a
cyclical basis, and yet, despite all of the
column inches devoted to the subject
and nudges from fund companies, the
conclusions are often the same: Sell your
winners and buy your losers. Beyond
that, there is absolutely no cut-and-dried
strategy that wins the rebalancing wars,
although there are plenty who’ll tell you
they’ve got the magic formula.
And by the way, that formula keeps
changing. In managing its ETF strate-
gic portfolios (yes, Vanguard has ETF-
only portfolios) Vanguard switched from
semiannual to quarterly to monthly rebal-
ancing over time. You’ll find other rebal-
ancing approaches employed and pro-
moted within the firm. Even Vanguard
doesn’t have a single preferred strategy.
But let’s ask the basic question: Is
rebalancing really a panacea? And if so,
what kind of rebalancing is best?
Dan and I spent some time digging
into the numbers you’ll see below, but
we’ve come to the conclusion that long-
term investors never need to rebalance.
(Well, almost never, and I’ll get to that
in a minute.) As Vanguard founder Jack
Bogle has said, “Formulaic rebalancing
with precision is not necessary.”
Managing Risk
Proponents of rebalancing often say
that is a disciplined way to sell high
(selling what has done well) and buy
low (buying what has lagged). And
buying low and selling high has always
been the formula for boosting returns.
As you’ll see, rebalancing is really
all about risk control—by sticking to
a targeted allocation between stocks
and bonds, the argument follows, you
can effectively manage the overall risk
or volatility of your portfolio through
continuing market cycles. In the end,
however, you don’t end up improving
returns through systematic rebalancing,
REBALANCING
To Re or Not to Re, That Is the Question
Never Rebalancing Leads to
Stocks “Taking Over”
12/87 12/91 12/95 12/99 12/03 12/07 12/11 12/15
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Total Bond Market
500 Index