Portfolio rebalancing

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
pitz
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Portfolio rebalancing

Post by pitz » 16 Nov 2005 20:29

I have, in my RRSP, implemented the following mix of index funds:

60% TSX Composite Index Fd.
20% USA Dow30 Index Fd.
20% MSCI EAFE Index fd.

(and yes, I did shop around for the lowest MERs possible, and none are clone funds).

Because of the no-load nature of the funds I bought, I can rebalance as much as I want without fees.

How should one determine the optimal interval over which rebalancing is to occur in such an instance? I could rebalance weekly, monthly, bi-weekly. Does over-rebalancing, in a fee-less environment, have serious drawbacks?

I haven't found any references in financial texts or elsewhere to suggest that there is an appropriate interval. Most of the discussion I have seen here and elsewhere centers on tax effects (not relevant in a RRSP), or transaction fees (once again, not relevant to the index funds I referenced above -- I already pay a MER, and my account isn't large enough to bother with ETFs yet).

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Post by ig17 » 16 Nov 2005 20:49

W.Bernstein, Case Studies in Rebalancing
So, what can we conclude from all this?

* Monthly rebalancing is too frequent.

* There are small rewards to increasing one's rebalancing frequency from quarterly up to several years, but this comes at the price of increased portfolio risk.

You makes your choice and you takes your chances, but don't sweat this one too much. The returns differences among various rebalancing strategies are quite small in the long run.
Added:

See also Momentum. How Random a Walk?, from the same author.
For the sheltered asset allocator, the message is loud and clear: Do not rebalance too frequently. ... For practical purposes, this means no more than annually, and preferably less.
Last edited by ig17 on 16 Nov 2005 21:09, edited 1 time in total.

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Bylo Selhi
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Post by Bylo Selhi » 16 Nov 2005 21:00

Larry Swedroe, various books, but this from Google's cache:
Swedroe suggests a "5/25 percent rule" for rebalancing. That is, rebalance if your asset mix has strayed either more than 5 percentage points or 25 percent from the target. If your target is 10 percent small-cap U.S. stocks, you would rebalance if they grew to more than 12.5 percent or became less than 7.5 percent (a 25 percent difference).

More important than any particular rule, however, is having a plan and following it. "There is no magic in the 5/25 percent rule per se," Swedroe said. "The important thing is the discipline."

In an interview, Swedroe also made these points:
-The main purpose of rebalancing is not to increase returns. (Any time you sell stocks and buy bonds you are lowering future expected long-term returns, according to MPT.) Rather, the purpose is to control risk.
-While many people think of rebalancing as something to be done once a year, you should do it every time you have new money to invest. If you are adding to your mutual fund portfolio every month, for example, you can buy more of the asset class that has not done as well.
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Post by scomac » 16 Nov 2005 23:03

Sometime ago, I recall reading an academic article that had determined the optimal interval (from a risk/reward basis) for rebalancing was every other year based on a long term statistical study. The author's argument was that asset classes would outperform/underperform on a cyclical basis, therefore the longer interval allowed you to capture more of the return premium without unduly affecting portfolio risk. IIRC, this was published in a finance journal so perhaps Norbert knows of the one I speak and may be able to link to it.
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Post by Norbert Schlenker » 17 Nov 2005 12:00

scomac wrote:IIRC, this was published in a finance journal so perhaps Norbert knows of the one I speak and may be able to link to it.
I don't remember it, probably because I wouldn't have believed it even if I'd seen it. The problem with all of these things is that they're so incredibly sensitive to time interval and which country you're talking about.

Consider Japan as an example. It had a really long bull run starting in the 70s and extending into the early 90s and has been death every since. The typical Japanese investor with typical home country bias who ran a rebalancing simulation would almost certainly come up with some really long time (10-15 years) as being optimal.
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Post by Shakespeare » 17 Nov 2005 12:02

I prefer threshold rebalancing (say, Swedroe's 25/5) to timed rebalancing, unless you are doing the latter by adding or withdrawing funds to (or from) what's the most off-target during either accumulation or withdrawal.
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Post by gummy » 17 Nov 2005 12:33

There's an really neat M* essay by Peter Vann with more than you'll want to know 'bout rebalancing. :D

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Post by Shakespeare » 17 Nov 2005 12:38

Thanks, gummy. That's an excellent link.
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Post by gummy » 17 Nov 2005 12:50

I dunno 'bout the math, but they is some pretty pictures here.

Makes me think you might want to forget fixed-period rebalancing (as Shakes suggests).
Perhaps you could toss a die with sides labelled 3 mths, 6 mths, 12 mths etc. :shock:

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Post by DenisD » 18 Nov 2005 00:45

I prefer threshold rebalancing too, although I don't have any hard and fast rules. Tend to give the more volatile positions more room. Leaving it discretionary lets me indulge in market timing in a fairly harmless manner. :wink:

Of course, I rebalance my stock screens when I refresh them every 6 or 12 months.

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Post by ronjoh » 19 Nov 2005 14:58

On the subject of rebalancing, does anyone know of a web site, similar to the Morningstar portfolio exray, for Canadian funds and stocks?

Thanks
Ron

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Post by ronjoh » 19 Nov 2005 15:03

PS Is there a good software package (or website) available for monitoring allocations (ie Quicken - which Im not familiar with)

Thanks again
Ron

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Post by martingale » 19 Nov 2005 15:20

Think of the process you used to set your level of investment in each market. It was a pretty fuzzy process, no? How confident are you that you have set the right proportions? You may have estimated the relative size of world markets, or determined it some other way. I bet you aren't more than 75 or 80% sure you got it right. As a result you should be pretty loose with your rebalancing. If it's 10% off your targets, that may well be within your "margin of error" anyway. I would set threshholds with fairly loose bands around them ("I will reset it to 60% if it climbs above 75%") and I'd go check not more than once or twice a year to see whether the threshold had been exceeded. If you were going to rebalance periodically rather than by a rule I'd agree with the two year rule as well.
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Post by Arby » 19 Nov 2005 15:26

ronjoh wrote:On the subject of rebalancing, does anyone know of a web site, similar to the Morningstar portfolio exray, for Canadian funds and stocks?
The GlobeInvestor Gold website has a feature called Portfolio Analyzer which shows the break down of your portfolio according to various allocations (e.g. asset class, country, sector). It supposedly analyzes the individual holdings of your mutual funds to determine the allocations.

You have to pay for GlobeGold, but you get it for free (renamed WebBroker Select) if you qualify for President's Account at TDWH.

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Post by Bylo Selhi » 19 Nov 2005 16:10

ronjoh wrote:PS Is there a good software package (or website) available for monitoring allocations (ie Quicken - which Im not familiar with)
Quicken has this feature, however it's too limited to be of much value for any but the most simplistic portfolios. It's really not that hard to monitor asset allocation with any spreadsheet program, or even by hand, especially if you do so only once a year. Create a list of all the assets in your portfolio with their current market values, assign each an asset class (several assets could belong in one class) and with a few additions and divisions you're done. It gets slightly more complicated if you have some US$-denominated stuff like stocks or ETFs. In that case just convert their current values to CA$ first.
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Post by DenisD » 19 Nov 2005 17:01

You could check out How to track investments and this spreadsheet

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Post by Adrian » 19 Nov 2005 17:19

Periodic rebalancing is but one important tool of portfolio management.

For many investors a reasonable frequency is to rebalance when funds go into an account or when funds are withdrawn. A once or twice a year tweak works quite well for most.

I'm not a fan of automatic rebalancing. I've seen portfolios that were rebalanced to minute and precice targets every month. Rather tax inefficient to say the least.

The bottom line is don't get carried away with this.

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www.kcmwealth.com

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Post by ronjoh » 19 Nov 2005 17:39

Thanks guys for the good info.

What I am really looking for is an anaysis similar to the Morningstar xray (which doesn't apply to Cdn funds). It provides a few quick breakdowns such as stock style diversification, sector holdings, etc..

I feel this would be a valuable tool to quickly determine where you might be overweighted (sector, style, country) etc. using both stock and fund data. The results are very fast compared to doing the analysis on a spreadsheet.

I agree, rebalancing to targets would be better done on a spreadsheet.

Thanks
Ron

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Post by DenisD » 27 Nov 2005 01:12

Here's what Swensen has to say about rebalancing in his book, Unconventional Success:
Frequent rebalancing activity allows investors to maintain a consistent risk profile and to exploit return generating opportunities created by excess security price volatility. Moreover, real-time rebalancing tends to cost less, as trades generally prove accommodating to the market. Frequent rebalancers buy in the face of immediate declines and sell in the face of immediate increases, in both cases supplying liquidity for traders pursuing the opposite, predominant tack.

...

The university's endowment enjoys tax exempt status, allowing frequent trading without adverse tax consequences associated with realization of gains.

...

In fiscal year 2003, Yale executed approximately $3.8 billion in rebalancing trades, roughly evenly split between purchases and sales. Net profits from rebalancing amounted to approximately $26 million, representing a 1.6% incremental return on the $1.6 billion domestic equity portfolio.

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Post by uhoh » 11 Dec 2005 10:10

ronjoh wrote:
What I am really looking for is an anaysis similar to the Morningstar xray (which doesn't apply to Cdn funds). It provides a few quick breakdowns such as stock style diversification, sector holdings, etc..
it doesn't? what about morningstar.ca?

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Post by Taggart » 22 Dec 2005 18:02

Getting Going: Why you shouldn't massage your portfolio every year

Wednesday, December 21, 2005

By JONATHAN CLEMENTS, The Wall Street Journal

Take your pick....

"There's significant evidence of momentum in asset-class returns, so you don't want to rebalance too often," says William Bernstein, an investment adviser in North Bend, Ore. "If you're rebalancing each asset class every three or four years, you're probably doing it about right."

or.......

There is, however, a risk in waiting. The further your portfolio strays from your target mix, the harder you will get hit if the market turns against you. Indeed, Richard Ferri, president of Portfolio Solutions in Troy, Mich., worries that less-frequent rebalancing is maybe too clever.

"If you're a sophisticated investor, you can look at the momentum and you might let it run a little," he says. "But for most people, annual rebalancing works just fine. It's 'Happy New Year,' I've got to rebalance my portfolio."

http://www.post-gazette.com/pg/05355/625851.stm

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Post by martingale » 23 Dec 2005 04:47

Frequent rebalancers make a lot of money for their brokers in the form of excessive commissions. Rebalance whenever your portfolio strays beyond your target bands, but be sure and make those bands nice and loose.

If when you were working out your targets you couldn't decide whether a particular asset class should be 5% or 15% of your portfolio it would be really silly to have a band that ranged from 8-12%. The band should be at least as wide as your uncertainty over the correct proportions.
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Post by Taggart » 19 Jan 2006 07:26

Globefund.com: Is your portfolio out of whack?

By ROB CARRICK

Thursday, January 19, 2006

"After three rip-snorting years for the stock market, there's just one thing to do with your Canadian equity funds and stocks.

Sell 'em down, baby. Not all the way to zero, but certainly down to the level specified in the blueprint that you or your investment adviser used to construct your portfolio."

LINK

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Post by Bylo Selhi » 26 Jan 2006 12:48

Portfolio Rebalancing in Theory and Practice (PDF) [Vanguard, Jan06]
Based on reasonable expectations about return patterns, average returns, risk, and correlations, we conclude that for most broadly diversified stock and bond fund portfolios, annual or semiannual monitoring, with rebalancing at 5% thresholds, produces an acceptable balance between risk control and cost minimization. To the extent possible, this rebalancing strategy should be carried out by appropriately redirecting interest income, dividends, new contributions, and withdrawals.
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Post by Norbert Schlenker » 04 Apr 2007 13:09

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