A lot of investment experts advice that we should rebalance our investment portfolio regularly. But does it really help.
John Bogle, whose advice is sane and straightforward writes in his blog:
Sorry it’s taken me so long to respond to your thoughtful note. Busy!
We’ve just done a study for the NY Times on rebalancing, so the subject is fresh in my mind. Fact: a 48%S&P 500, 16% small cap, 16% international, and 20% bond index, over the past 20 years, earned a 9.49% annual return without rebalancing and a 9.71% return if rebalanced annually. That’s worth describing as “noise,” and suggests that formulaic rebalancing with precision is not necessary.
We also did an earlier study of all 25-year periods beginning in 1826 (!), using a 50/50 US stock/bond portfolio, and found that annual rebalancing won in 52% of the 179 periods. Also, it seems to me, noise. Interestingly, failing to rebalance never cost more than about 50 basis points, but when that failure added return, the gains were often in the 200-300 basis point range; i.e., doing nothing has lost small but it has won big. (I’m asking my good right arm, Kevin, to send the detailed data to you.)
My personal conclusion. Rebalancing is a personal choice, not a choice that statistics can validate. There’s certainly nothing the matter with doing it (although I don’t do it myself), but also no reason to slavishly worry about small changes in the equity ratio. Maybe, for example, if your 50% equity position grew to, say, 55% or 60%.
In candor, I should add that I see no circumstance under which rebalancing through an adviser charging 1% could possibly add value.
Use your own judgment, but perhaps these comments will help.
I thought: Let me put it to test.
So, I took 8 asset classes, excluding cash: Gold, Real-estate, Commodities, US large-cap, US small-cap, International, Emerging and Long term bonds. I collated the annual returns for these asset classes from 2002-2011.
The annual returns are taken from these charts: The Importance of Diversification. For the annual returns for Gold, I used this chart. I cannot vouch for the accuracy of the data. But the main point is to see whether “rebalancing” is better than “not rebalancing” or not.
The collated data can be seen in this excel sheet. For US large cap, I have taken the average of large cap value and large cap growth. For US small cap, I have taken the average of small cap value and small cap growth.
The results are as follows:
- CAGR for a “not rebalanced” portfolio between 2002-2011: 10.15%
- CAGR for a “rebalanced” portfolio between 2002-2011: 10.48%
The difference is as Jack Bogle says is “noise”.
To rebalance 10 different asset classes, there is a lot of transaction costs, slippage and tax(if you are doing this in taxable accounts).
But it is easier to buy equal amounts (say $10000 of each of the asset classes) and forget about it for 10 years and get a 10.15% annual return.
The CAGR for investing only in the US large cap was 3.1%
So my conclusion is: If you are investing a decent amount of money, then do not rebalance. Invest equally in a set of 5-10 asset classes and forget about it. You will get a good return in most times.