Portfolio Rebalancing Frequency: Even Less Than Annually?

scaleHere’s another data point on the debate on how often to rebalance your portfolio to your target asset allocation. Econompic Data writes about rebalancing a portfolio back to 60% S&P 500 / 40% Barclays Aggregate Bond index from 1976-2014 and finds that rebalancing every 3 years actually produced slightly better average annual returns that rebalancing monthly (via Abnormal Returns):

econompic_rebal

Momentum is cited as a potential reason why this works. Looks good at a glance, but look at that y-axis. We are comparing 10.3% and 10.2%. Is that really significant?

I would point out that in a previous Vanguard research article, a similar backtest was done on a 60/40 Broad US Stock/Broad US Bond portfolio rebalanced across various thresholds from 1926-2009. Their conclusion (emphasis mine):

We found that no one approach produced significantly superior results over another. However, all strategies resulted in more favorable risk-adjusted portfolio returns when compared with returns for portfolios that were never rebalanced.

vgrebal

From a 2008 paper from Dimensional Fund Advisors:

Aside from avoiding excessive trading, there are no optimal rebalancing rules that will yield the highest returns on all portfolios and in every period.

From advisor and author William Bernstein:

The returns differences among various rebalancing strategies are quite small in the long run.

Instead of there being a benefit to rebalancing less often, it may just be safer that the frequency doesn’t matter. On the other hand, given the potential cost of rebalancing from taxes, commissions, and bid/ask spreads perhaps lowering the frequency doesn’t hurt.

I think the most important thing to note is that in every test case above, the rebalancing was done on a strict schedule and without emotion. The problem you are really trying to avoid is being afraid buy whatever has been getting crushed and selling what has been doing awesome. There’s that behavioral/emotional component again.

As for me, I try to check my portfolio once a quarter, but rebalance no more than once a year. An annual frequency is as easy to remember as your birthday, it’s not too often and not too seldom, lots of smart people are proponents, and it gives me the opportunity to do tax-loss harvesting. I use tolerance bands such that if my major asset classes are off by more than 5%, then I will rebalance. Otherwise, I “rebalance lite” year-round using any new money to buy underweight asset classes.

The Only Two States of Your Portfolio: Happy All-Time High or Sad Drawdown

emoinvestQuick question – What was the highest value ever for your investment portfolio? Now, what was the value exactly a year before that? You probably know the answer to the first question, but not the second, even though both have little to do with your final portfolio value.

I am currently reading the e-book Global Asset Allocation by Meb Faber and he had a good observation that I don’t recall ever expressed in this specific manner (emphasis mine):

It is a sad fact that as an investor, you are either at an all-time high with your portfolio or in a drawdown – there is no middle ground – and the largest absolute drawdown will always be in your future as the number can only grow larger.

We tend to carry the highest value of our portfolio around in our heads because of the powerful cognitive bias of anchoring. Let’s say that 10 years ago you started with $20,000 and today with your contributions and investment growth your total is $100,000. If next year your portfolio experiences a drawdown to $80,000, you’ll probably identify your portfolio as being 20% down from $100,000, as opposed to a 400% increase from $20,000. $100,000 is “what you had” and you will forever be anchored to that number, even if for it only lasted just for a day.

That is, until you reach another all-time high (yes! $105,000) and that will be your new anchor. (This applies to individual holdings as well – I’ve found this especially pervasive when using brokerage smartphone apps that allow me to frequently check in with just a tap.)

If your portfolio is anything like mine, it has been repeatedly been hitting all-time highs for a year or two. The problem is, sooner or later, there is a 100% chance I’ll be stuck in a prolonged drawdown phase. I will think about my high-water value every time I check my statements (which is why perhaps it is better not to check your investment value much more than once a year). I will question my existing asset allocation and how to invest my new money.

Now add in loss aversion – the other finding from behavioral economics that people feel the pain of losses much more severely than the pleasure of gains (studies suggest we hate losses roughly twice as much as gains).

That means drawdowns are always lurking around the corner, and we hate them twice as much as any investment gain. It’s no wonder that investors are often their own worst enemies by not sticking to their investment plans.

Slate from Chase: 0% APR For 15 Months + NO Balance Transfer Fee for 60 Days + Free FICO Score

Slate from Chase Visa

Updated with free FICO score information. Looking to pay down debt in 2015? Transfer your balances to the Chase Slate® Card and get 0% APR For 15 Months and pay NO BALANCE TRANSFER FEE if done within 60 days of account opening. You won't pay any m … [Read the rest]

Blue Cash Preferred from American Express Review: 6% Back on Groceries + New Bonus

Blue Cash Preferred from American Express Banner

Update: There is a new link for this card which is offering a $50 statement credit after first purchase within 3 months of card membership, plus another $150 statement credit after $1,000 in purchases within 3 months of card membership. The sign-up … [Read the rest]

The Affluent Investor by Phil DeMuth – Book for $100,000+ Club

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This week I've been trying to catch up on my book reviews (you should see my "to read" shelf!), and after a good beginner book I thought I'd write about a good intermediate-to-advanced book. You've probably noticed there are a lot of starter books … [Read the rest]

Vanguard High-Yield Corporate Bond Fund Review (VWEHX)

vghighyield

The Vanguard High-Yield Corporate Bond Fund (VWEHX, VWEAX) is a low-cost, actively-managed bond fund that invests in medium- and lower-quality corporate bonds and is advised by Wellington Management Company. I don't own any in my retirement … [Read the rest]

Book Review: The New New Thing: A Silicon Valley Story by Michael Lewis

newnewthing

Somehow I picked up a copy of The New New Thing: A Silicon Valley Story, which is a Michael Lewis bestseller published back in 1999 about the internet boom. The central character is Jim Clark, founder of Silicon Graphics (SGI), Netscape, and … [Read the rest]

The Elements of Investing – Book Review (Updated Edition)

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There are two major types of investing books for beginner investors: "Instructional to-do list" books basically tell you what you should do. "Inspirational big-picture" focus more on the philosophical reasons why you should do those things. Both … [Read the rest]

5% Cash Back Credit Cards: Rotating Categories Update 2015

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2nd quarter activation for 2015 now open! The credit cards below offer a hefty 5% cash back on certain categories that rotate each quarter. It takes a little extra attention, but I also rack up over a hundred dollars in additional rewards per year … [Read the rest]

1,000 Free Hilton Honors Points For Updating Password

Hilton is offering people 1,000 Hilton HHonors points for creating a "real" password to replace their previous 4-digit PIN. Took me less than a minute. You must do this between March 12th and March 25th, 2015, and points will be posted in 6-8 … [Read the rest]

Beware of Mutual Funds That Artificially Juice Their Dividend Yield

juicingdividends

I like seeing my dividend income roll in each quarter, as do many other investors. But are mutual funds artificially "juicing" their reported dividend yields to attract investors? This is explored in a recent academic paper Juicing the Dividend … [Read the rest]

FidSafe Review: Free Digital Document Storage from Fidelity

fidsafelogo

I have a couple of accounts at Fidelity Investments (solo 401k and taxable brokerage), and recently they sent me letter about a new service. FidSafe is a website that stores digital copies of documents for free and is open to the public, no … [Read the rest]