14
•
Fund Family Shareholder Association
www.adviseronline.combuying and holding. The first required
a reset to 50/50 whenever the difference
between stock and bond allocations was
5% or greater. The second trigger for an
adjustment was a 10% allocation differ-
ential. Not surprisingly, you can see the
static portfolio’s outperformance surging
in the late 1990s and its minor underper-
formance from the depths of the recent
bear market in the chart below to the
right, which looks a lot like the chart on
page 13 of the calendar-based rebalanc-
ing strategies.
The numbers in the table below con-
firm that periodic and threshold rebal-
ancing get you to the same place with
similar risks. As I said before, rebalanc-
ing is about risk control, not improv-
ing returns—and no single rebalancing
strategy trumps another.
The threshold strategy is popular in
the press and academia, but consider
the kind of trading this strategy gener-
ates. As I go through the numbers, ask
yourself whether you could or would
follow such a strategy on your own.
Obviously, if you don’t rebalance,
there are no trades required. But if you
decided to trade your 50/50 portfo-
lio whenever the allocations between
stocks and bonds broadened out by
10% or more, you’d have made 16
trades over the past three decades or so.
That sounds pretty reasonable, right?
Heck, even a strategy that rebalanced
on 5% spreads would have generated
just 46 trades, or fewer than two per
year. That sounds doable, right?
The trouble is that rebalancing on
percentage thresholds can mean going
years without a trade, and then making
a flurry of changes. And it can mean
making trades at times when those
trades are the hardest to execute. Take a
look at the table below. As mentioned,
while the 10% strategy only necessi-
tated 16 trades in nearly three decades,
the shortest period between trades was
just three months, and the longest was
more than eight years.
Consider that following the 10%
strategy would have dictated trad-
ing
into
stocks at the end of October
2008, after the market fell 24.2% in
September and October. Could you
have done that? Would you have done
that? How about in February 2009,
when the portfolio you rebalanced in
October once again was more than 10%
out of whack? Would you have had to
nerve to buy stocks at what, in retro-
spect, was the absolute bottom of the
financial crisis bear market? As I said,
it’s easy to talk about rebalancing—it’s
a lot harder to do it, particularly in peri-
ods when it provides the most benefit.
Okay, maybe 10% is too much. How
about 5%? Well, those 46 trades, which
average out to about one trade every
seven months, or less than two per year,
didn’t occur with lots of regularity either.
In fact, during 2008 and 2009 alone,
you’d have executed nine trades. And that
meant selling bonds to buy stocks into the
teeth of the credit crisis in 2008 and early
2009, only to turn around and sell stocks
to buy bonds as markets rebounded in late
2009. Easier said than done.
As I mentioned at the outset, therein
lies the main issue with rebalancing strat-
egies of all stripes: The investor can at
times be his own worst enemy. I’ll return
to this point after looking at Vanguard’s
latest rebalancing recommendation.
Combine theTwo?
As I mentioned, Vanguard’s latest
advice combines both a periodic review
with the threshold strategy. Specifically,
Vanguard concludes that “for most
broadly diversified stock and bond fund
portfolios…
annual or semiannual
monitoring, with rebalancing at 5%
thresholds
, is likely to produce a rea-
sonable balance between risk control
and cost minimization for most inves-
tors. Annual rebalancing is likely to be
preferred when taxes or substantial time/
costs are involved.”
Vanguard’s whitepaper has some
numbers in it, but of course Dan and
I wanted to take our own look. We put
our 50/50 portfolio through Vanguard’s
recommended strategies: First, rebal-
ancing annually in January if the dif-
ference between stock and bond alloca-
tions was 5% or greater at the end of
the year. Then running the same exer-
cise, but looking to rebalance in both
January and July if the portfolio was
past the 5% skew. As you can see, the
top left chart on the next page doesn’t
look all that different from either the
periodic or threshold-only charts.
Following the annual review with
rebalancing at a 5% threshold would
have seen you trade the portfolio in 18
out of the 29 years, or 62% of the time.
And reviewing the portfolio semiannu-
ally would’ve resulted in 23 trades. So
combining the periodic and threshold
approaches does reduce the number of
times you trade, versus either strategy
individually, but at the end of the day,
you are winding up in the same place.
Trading Has Its Costs
The strongest argument against
becoming a rebalancing fanatic is cost—
something which I don’t believe gets
enough analysis in all the blather over
rebalancing. So far when conducting this
analysis, I assumed that all distributions
were reinvested along the way, and did
not factor in transaction fees or taxes on
>
Easy on Paper, Not So Easy To Do
Trades
Avg.
Mos.
Btwn.
Trades
Fewest
Mos.
Btwn.
Trades
Most
Mos.
Btwn.
Trades
Terminal
Value of
$100
Annualized
Return
Basis
Pt
Diff.
MCL
No rebalancing
0 — — — $1,067
8.50% -34.5%
Rebalancing on a 10% spread 16 22
3
99 $1,020
8.33% (17) -28.4%
Rebalancing on a 5% spread
46
7
1
50 $1,045
8.42% (8) -26.9%
Note: Table shows results for a portfolio allocated 50/50 to 500 Index and Total Bond Market from Dec. 1986 through Dec. 2015.
Lots of Work,
Little Payoff
No Rebalancing
10% Rebalancing
5% Rebalancing
12/87
12/91
12/95
12/99
12/03
12/07
12/11
12/15
$0
$200
$400
$600
$800
$1,000
$1,200
Note: Threshold-based rebalancing strategies.