If and how to rebalance?

[Newroad]

Hi All.

With the "completion" of my pseudo-HYP (see here: https://www.lemonfool.co.uk/viewtopic.php?f=15&t=40201) the question now moves to if and how to rebalance. Not to do so is an article of (Pyadic?) faith for some - if so, turn away now. For those who it isn't or may not be, please continue.

My thinking on this and a number of other matters is heavily influenced by Carvers book "Smart Portfolios" (see here: https://www.lemonfool.co.uk/viewtopic.php?f=56&t=33659&p=493172&hilit=carver#p493172). Towards the end of this book, Carver addresses the topic in some detail. I recommend you read the relevant sections if possible, but I will try and outline the key take-aways below. Carver suggests that you need to take into account two factors

A no-trade zone (a tolerance, if you will, before you should rebalance)
A minimum trade size (so that costs don't outweigh the benefits)

The former is relative to your portfolio the size, the latter is not in general (with one exception that I will mention). The idea is to get the balance right, avoiding both over-trading (increasing costs) and leaving your portfolio unbalanced for too long.

No-trade zone: Carver's testing and analysis suggest that this should be one half of your average (mean) portfolio holding.
Minimum trade size: Carver suggests, at time of writing, this should be £250 (or $150). This was premised on the then brokerage fees he was paying - £6 in the UK. He noted this was likely to change and/or be different for others, so noted to pro-rate if so.

So, let's look at a worked example, not dissimilar to my own scenario for this portion of our portfolio. Assume you have a £50K portfolio of 25 stocks. Your "no-trade zone" would be £1000 (half of £50,000 / 25). Assuming an equal weighted target portfolio, i.e. aiming at £2,000 per stock, your initial no-trade zone would be £1,500 - £2,500 for each. This needs to be expanded by the minimum trade size, £250 as noted, so your final no-trade zone would be £1,250 - £2,750. So, if a stock fell below £1,250, you would buy/trade as needed to get it back to £1,500 (the minimum of the no-trade zone). Similarly, if rose above £2,750, you would sell/trade as needed to get it back to £2,500 (the maximum of the no-trade zone).

That's more or less it. The one quirk is for large portfolios, where moving the market is more of a factor than the trading costs - in which case, he suggests a minimum trade size of 0.1% of the portfolio (e.g. £1,000 on a £1,000,000 portfolio). As to how often, for the average retail portfolio, Carver suggests that annual rebalancing is fine.

Am I going to do this myself? Yes, more or less. One adjustment I am going to make is to the minimum trade size for me. My rule is broadly speaking that transaction costs should not exceed 1% of the transaction. As I pay £3 brokerage (with IBKR) then for buys, which include stamp duty, my minimum trade size will be £600, for sells, which don't, my minimum trade size will be £300. All other things being equal, this will reduce the number of transactions I am likely to need to do, at risk of a portfolio being out of balance for longer. The fact that I intend to add £600 a month (plus dividends) anyway mitigates this somewhat, at least on the buy side, as each month there is a mini-rebalance with one stock. I should also note that my portfolio is risk weighted rather than equal weighted (as Carver recommends) - but this does not affect the application of the principles outlined.

I hope this is of interest/help to some and perhaps leads to further discussion.

Regards, Newroad

[funduffer]

I think this method is over-restrictive.

My average holding is roughly £3000, so that would give me a non-trade zone of roughly £2250 to £3750.

If I followed this, I would have to adjust 3/4 of my portfolio shares. (My trading costs are £5 for a sell and £5 + stamp duty for a buy).

I think the no trade zone needs to be much wider.....

Also, HYP is about income, so I would have thought yields should come into the re-balancing decision as well.

I think tjh may be along soon to summarise his method, but if not, you will be able to find it easily on this board.

FD

[Newroad]

Hi FundRuffer.

That's interesting - as I think the no-trade zone produces something quite wide. My pseudo-HYP has been being built up for around 18 months or so now, and nothing yet is particularly near a forced rebalance. As an aside, adding the minimum trade in for brokerage, your "final" no-trade zone for Carver's method would expand to around £2,040 to £3,960.

However the above may affect 3/4 of your shares, were you to adopt it, that would be a one off reconciliation of sorts - it would then be more relevant perhaps as to how many would typically break out of the range thereafter annually.

Yields do come into his decision making as well, but it depends how you mean it. Carver in particular discusses replacing one share for another based on yield ("substitution" as opposed to "rebalancing" in his parlance). That's also a section worth reading for many and at some point will become relevant for me.

Regards, Newroad

[tjh290633]

In my view the limits are far too tight. It will end up with too frequent trading. The top end should be nearer 10% of the portfolio value. I would put it at twice the median holding value for a 25-share portfolio.

As to which share to top up, originally I flagged any share less than half of the median as the one to top up. Then I devised the method embodied in the HYPTUSS (High Yield Portfolio Top-up Spread Sheet). This is available to all users and takes guesswork out of the equation.

Fundamentally you need two limits - maximum permissible weight and minimum acceptable yield. What those are depends on the size of the portfolio and current market yield. You cannot work in absolute monetary values. Neither can you be rigid about yields, which will vary from time to time. Fundamentally size matters and affects trading charges, for which 1% is a desirable aim for purchases. Ideally it can be much lower as holding sizes increase.

I suggest that is wrong to try to reinvent the wheel.

TJH

[Newroad]

Hi Terry.

I presume "the wheel" in context is what is embodied in HYPTUSS? My understanding is that has been developed anecdotally, as opposed to using any theory, and has worked for you (and perhaps others) - fair enough. My own approach is still developing, influenced by Carver (not just in the pseudo-HYP) but the refinements are getting smaller.

Carver's approach is, as far as I can ascertain, based first on theory, then testing and analysis at scale - probably using lots of Monte Carlo simulations and similar. I would say each approach has validity and that presenting one of them as an alternative should not be regarded as heresy (and more than your own approach is heresy vs the Pyadic "true buy and hold" way of thinking).

So, I have tried to give a flavour of Carver's approach - those interested can follow up (or discuss). Those who aren't, that's OK too. On a related note, for the theory behind the simplified theory, Carver cites "Optimal Trading Under Proportional Transaction Costs", Richard Martin, Risk magazine, 2014.

On your more specific points

The comment about 10% of portfolio appears to be out of context - what portfolio, or kind of portfolio, were you thinking of?
It can't be the 25 share (£50K) example portfolio noted, as you have said twice median for that, which would be about £4K or 8%
On the bit about minimum acceptable yield, that is fine if you want it - Carver's rebalancing etc ideas still work if so - but to get the sectoral variation (which Carver also advocates) you would likely to need to go down in company size (e.g. FTSE250) or out in geography (Europe - maybe even US)
The trading charge angle was acknowledged - not sure of the additional point, if any, being made

Regards, Newroad

[tjh290633]

Hi Terry.

I presume "the wheel" in context is what is embodied in HYPTUSS? My understanding is that has been developed anecdotally, as opposed to using any theory, and has worked for you (and perhaps others) - fair enough. My own approach is still developing, influenced by Carver (not just in the pseudo-HYP) but the refinements are getting smaller.

Carver's approach is, as far as I can ascertain, based first on theory, then testing and analysis at scale - probably using lots of Monte Carlo simulations and similar. I would say each approach has validity and that presenting one of them as an alternative should not be regarded as heresy (and more than your own approach is heresy vs the Pyadic "true buy and hold" way of thinking).

So, I have tried to give a flavour of Carver's approach - those interested can follow up (or discuss). Those who aren't, that's OK too. On a related note, for the theory behind the simplified theory, Carver cites "Optimal Trading Under Proportional Transaction Costs", Richard Martin, Risk magazine, 2014.

On your more specific points

The comment about 10% of portfolio appears to be out of context - what portfolio, or kind of portfolio, were you thinking of?
It can't be the 25 share (£50K) example portfolio noted, as you have said twice median for that, which would be about £4K or 8%
On the bit about minimum acceptable yield, that is fine if you want it - Carver's rebalancing etc ideas still work if so - but to get the sectoral variation (which Carver also advocates) you would likely to need to go down in company size (e.g. FTSE250) or out in geography (Europe - maybe even US)
The trading charge angle was acknowledged - not sure of the additional point, if any, being made

Regards, Newroad

Yes, the wheel is essentially the HYPTUSS. The thing that I feel is wrong with your approach is that the limits are far too tight.

Regarding your specific points:

1. Originally I chose 10% as a limit when my portfolio was in the upper teens. When 20-strong, 10% is twice the median.

2. Just when to reduce that multiple is debatable, but I went to 1.5 times when I was over 30 constituents. However, actual holding size matters, and the situation is radically different if your median is £2,000 as compared with £10,000 or £20,000.

3. Minimum acceptable yield is very subjective. For much of the time I have used 2% or half the index yield, but it is not compulsory. I hold HLN and IMI, both below the level. If you sell a 2% yield share that was growing it's dividend at 10% per year and replace it with one yielding 4%, it will take 7 years to get back to where you started in terms of income, assuming that the other share holds it's dividend level.

4. Depending on the sector, you may have to go into the FTSE250 to find examples. That doesn't matter.

Must dash, medical appointment in 15 minutes.

TJH

[Dod101]

I have a mature portfolio of 30 shares about 2/3rds of which would qualify as income shares. I have in theory thus an average holding of about 3.5%. I am happy to tolerate a holding of up to 50% above that but it depends on the share. Minimum trading value needs to be at least £2,500 in my book to have any relevance and I tend to trade only in values of at least double that.

Do not get hung up on theories. See how the portfolio goes and play around with that. You will soon know where you feel comfortable.

Dod

[Charlottesquare]

Hi Terry.

I presume "the wheel" in context is what is embodied in HYPTUSS? My understanding is that has been developed anecdotally, as opposed to using any theory, and has worked for you (and perhaps others) - fair enough. My own approach is still developing, influenced by Carver (not just in the pseudo-HYP) but the refinements are getting smaller.

Carver's approach is, as far as I can ascertain, based first on theory, then testing and analysis at scale - probably using lots of Monte Carlo simulations and similar. I would say each approach has validity and that presenting one of them as an alternative should not be regarded as heresy (and more than your own approach is heresy vs the Pyadic "true buy and hold" way of thinking).

So, I have tried to give a flavour of Carver's approach - those interested can follow up (or discuss). Those who aren't, that's OK too. On a related note, for the theory behind the simplified theory, Carver cites "Optimal Trading Under Proportional Transaction Costs", Richard Martin, Risk magazine, 2014.

On your more specific points

The comment about 10% of portfolio appears to be out of context - what portfolio, or kind of portfolio, were you thinking of?
It can't be the 25 share (£50K) example portfolio noted, as you have said twice median for that, which would be about £4K or 8%
On the bit about minimum acceptable yield, that is fine if you want it - Carver's rebalancing etc ideas still work if so - but to get the sectoral variation (which Carver also advocates) you would likely to need to go down in company size (e.g. FTSE250) or out in geography (Europe - maybe even US)
The trading charge angle was acknowledged - not sure of the additional point, if any, being made

Regards, Newroad

3. Minimum acceptable yield is very subjective. For much of the time I have used 2% or half the index yield, but it is not compulsory. I hold HLN and IMI, both below the level. If you sell a 2% yield share that was growing it's dividend at 10% per year and replace it with one yielding 4%, it will take 7 years to get back to where you started in terms of income, assuming that the other share holds it's dividend level.



TJH

Sorry, is that not backwards?

[Newroad]

Hi Dod.

I think your opinion is entirely reasonable. However, there are some people who like to base stuff on underlying theory, or at least use it as a starting point.

Not Michael Gove of course - I'm sure he would have had entirely enough of experts and their theories

Regards, Newroad

[Dod101]

Hi Dod.

I think your opinion is entirely reasonable. However, there are some people who like to base stuff on underlying theory, or at least use it as a starting point.

Not Michael Gove of course - I'm sure he would have had entirely enough of experts and their theories

Regards, Newroad

Well I have tried all sorts of methods over the last 30 years or so but the best theory in my experience is not theory at all, it is experience, some will be bitter and some good. You learn (or need to learn) from experience. That is the best teacher. People who write books on theory no doubt make money but most of it will come from Royalties not investing.

Anyway, I agree broadly with TJH. The limits proposed are far too tight.

Dod

[Newroad]

That's sort of right, Dod.

The bit about teaching vs doing, so to speak. However, that implied criticism would be more founded for, say, a stock picker - if someone could outpick the market, why tell anybody about it?

Carver is not such a person - he does not proclaim to be able to divine which stocks to pick - indeed, he assumes otherwise. In context, he tries to explain how to give the best chance of producing the desired returns given an investors personal set of circumstances and beliefs, taking into account risk, costs etc.

So yes, he may well make some money on royalties, but for this type of book, it does not imply, IMO, that he's teaching because he can't do.

Regards, Newroad

[Dod101]

That's sort of right, Dod.

The bit about teaching vs doing, so to speak. However, that implied criticism would be more founded for, say, a stock picker - if someone could outpick the market, why tell anybody about it?

Carver is not such a person - he does not proclaim to be able to divine which stocks to pick - indeed, he assumes otherwise. In context, he tries to explain how to give the best chance of producing the desired returns given an investors personal set of circumstances and beliefs, taking into account risk, costs etc.

So yes, he may well make some money on royalties, but for this type of book, it does not imply, IMO, that he's teaching because he can't do.

Regards, Newroad

I can promise you my comments are sort of right. I am not criticising him particularly but I am cynical about anyone who professes to be able to advise us how to invest. Anyway, I wish you well as you need to start somewhere.

Dod

[Newroad]

Thank you, Dod.

I did indeed start somewhere, like you no doubt - and in my case, it worked accidentally very well for give or take a decade for the key amounts. In absolute terms, I would probably have been better had I never deviated from that somewhere (in rough terms, almost 100% FCIT for the kids JISA's - thought a bit of MYI from one grandparent, 100% ATST for the adult SIPPS, 100% WTAN for the adult ISA's).

However, I took a bite of the apple and we are now where we are. Let's hope I've done OK for the long term.

Regards, Newroad

[tjh290633]

3. Minimum acceptable yield is very subjective. For much of the time I have used 2% or half the index yield, but it is not compulsory. I hold HLN and IMI, both below the level. If you sell a 2% yield share that was growing it's dividend at 10% per year and replace it with one yielding 4%, it will take 7 years to get back to where you started in terms of income, assuming that the other share holds it's dividend level.



TJH

Sorry, is that not backwards?

Sorry, yes it is. I was in a hurry to go out. What I meant was, if you didn't make the change, the sold share will take 7 years to get to the level of income you achieved by making the change.

TJH

[Arborbridge]

Hi Dod.

I think your opinion is entirely reasonable. However, there are some people who like to base stuff on underlying theory, or at least use it as a starting point.

Not Michael Gove of course - I'm sure he would have had entirely enough of experts and their theories

Regards, Newroad

When I last looked, this was the HYP practical board, so why are we introducing theoretical methods by someone called "Carver"?

Don't muddy the waters by going off at a distracting tangent, please. Either run a HYP, near-HYP or don't. My advice is not to get distracted by theories which come and go - I've seen many of them go, BTW. HYP was devised from practical circumstances rather than theory - and the real world is the best teacher.
The interesting thing is that the great investors all have their stated methods, but then vary them according to experience or circumstance.

Basically, if you are interested in HYP, carry on HYPing. If tempted towards something else which suits you, then goodbye.

Arb.

[Bubblesofearth]

So, if a stock fell below £1,250, you would buy/trade as needed to get it back to £1,500 (the minimum of the no-trade zone).

How many times would you do this? My concern would be that you could end up pouring money into a black hole, i.e. a share that ends up at, or near to, zero. Chances are in any given portfolio you will end up with at least one of these. For example, would you have continued adding to a bank position back in 2007/8? Would this have been funded only with new money or through sales of other shares in the portfolio?

If you are going to average down then maybe put a limit on how much to invest in this way?

BoE

[idpickering]

How many times would you do this? My concern would be that you could end up pouring money into a black hole, i.e. a share that ends up at, or near to, zero. Chances are in any given portfolio you will end up with at least one of these. For example, would you have continued adding to a bank position back in 2007/8? Would this have been funded only with new money or through sales of other shares in the portfolio?

If you are going to average down then maybe put a limit on how much to invest in this way?

BoE

Good advice imho. I stop myself from continuing to perhaps grasping at falling knives (shares), by having a maximum spend limit on any given share in my 28 share HYP. Although I do have a double holding in LGEN, but that was intentional on my part.

Ian.

[moorfield]

When I last looked, this was the HYP practical board, so why are we introducing theoretical methods by someone called "Carver"?

Don't muddy the waters by going off at a distracting tangent, please. Either run a HYP, near-HYP or don't. My advice is not to get distracted by theories which come and go - I've seen many of them go, BTW. HYP was devised from practical circumstances rather than theory - and the real world is the best teacher.
The interesting thing is that the great investors all have their stated methods, but then vary them according to experience or circumstance.

Basically, if you are interested in HYP, carry on HYPing. If tempted towards something else which suits you, then goodbye.

Ouch! Out of bed the wrong side this morning? Don't forget we congregate annually here to worship a theoretical portfolio by someone called "pyad" - in the sense that far as I am aware (I may be wrong) it isn't actually real and he doesn't actually live off it. I thick such discussion should be welcomed here actually, you may/may not agree, but it's thought provoking at least.

If you are going to average down then maybe put a limit on how much to invest in this way?

This is one advantage of the TJH system IIUIC, a cap on the cost of portfolio holdings.

[vand]

There a perfectly valid school of thought that says you should avoid tinkering and rebalance as little as possible. As an well known example Buffett has let AAPL grow to, what, ~40% of the BRK portfolio? and the top 2 shares make up over half. If you have hard max position size limits, set them to moonshoot levels and allow yourself the chance to ride the moonshoot - they don't happen too often.

[Newroad]

Thanks, Moorfield.

I was thinking along similar lines as you (i.e. what's got into Arborbridge?).

If there is only one acceptable HYP, i.e. Pyadic, then the discussion here would be limited to where his guidance is missing/unclear. As noted elsewhere, the Carver approach advocates, all other things being equal, selecting the highest yielding share from a given pool in a given sector, so by any reasonable broader definition of HYP, it would seem to be in the spirit of the forum. However, if the post is reported and the moderators tell me to cease and desist, I of course would.

Similar for rebalancing - and few as far as I can tell adopt a strict Pyadic approach to buying and holding. It was for people who do rebalance in the context of their HYP who I thought may enjoy and perhaps even benefit from such a discussion.

{BubblesOfEarth & IDPickering} I considered your point (pouring money into a black hole) myself. I have currently concluded that topping up a given stock no more than once a year may be the answer (remember, I hold 22). However, for the avoidance of doubt, I don't believe Carver speaks on the matter.

{Vand} No issue if you want to avoid tinkering at all - I covered that early on in my OP.

Regards, Newroad