Why rebalancing your investment portfolio is not essential

There are many people who say that you should rebalance your portfolio at regular intervals or when a component goes beyond a predetermined band. Rebalancing can increase returns and decrease loss in your portfolio. But it is not simple or cheap.

If you have a multiple asset class portfolio then getting rebalancing the components is neither easy or cheap. If somebody can rebalance your portfolio for free, then you should definitely do it. But, if you are going to have transaction costs in buying and selling, then it is not worth it. I shall show you the evidence.

Most of us, when we invest, do not invest everything at once. If you have a 8 asset class portfolio and you want to invest $5000 a month, then you have to invest $625 in each asset class. If you have transaction costs in buying the asset class, it is a lot of expense. Then, at the end of the year, if you have to rebalance, then there are more costs. Not only costs, but also a lot of hassle because you may have to buy and sell small amounts and then keep track of everything.

This may be worth the trouble, if it gives a decent outperformance. But the evidence suggests that the outperformance is minimal.

Look at the figure below:

Rebalancing versus not rebalancing

The data is shown in the spread sheet here and the data is derived from Simba’s asset class returns from the Boglehead’s website which you can reach here.

Although the rebalanced portfolio outperforms in theory, transaction costs will eat up most of this out-performance. So in reality, both the rebalanced and the not rebalanced portfolios will have similar returns.

So what you can do is just buy, hold and never rebalance.

If you buying 8 asset classes, then you can buy one asset class every month for 8 months and then keep repeating for the rest of your life. If you decide to buy only 3 asset classes, then you can buy one asset class every month for 3 months and then keep repeating for the rest of your life.

  • The returns will be similar even of you do not rebalance.
  • Your investing will be on autopilot and you do not need to worry about rebalancing.
  • You will have less hassles.
  • You can be well diversified by investing in multiple asset classes.
  • You will become rich if you carry out such a plan for a long amount of time.

You can build wealth, ignore Wall Street and get on with your life, as Bill Schultheis says. So buy, hold and never rebalance. You will be alright.

 

Advertisements