The Lemon Fool

Morning All.

Out sub-portfolios are all slightly different, due to ages of their beneficiaries. On average though, they are close enough to 70/30 equities/non-equities (bonds and cash). In context, I think they can be considered loosely analogous to a classic 60/40 equity/bond portfolio.

I was wondering whether anyone has a reference to any theoretical work done on when/how/why etc to rebalance such a classic portfolio? I would be grateful for such information.

Absent that, my current thinking runs as follows

1. Equities +/- 10%: Rebalance as soon as practical (i.e. especially in the case of a crash, wait until spreads re-tighten to acceptable levels)
2. Equities +/- 5%: Rebalance quarterly
3. New Contributions: (Partially) rebalance monthly - which is what I already do
4. Otherwise: Leave alone

The theory re (1) above is that one might miss some further up/downside, but won't miss the opportunity that a correction allows. For the avoidance of doubt, +/- 10% on a 70% equity portfolio equates to +/- 7% of the whole portfolio (i.e. the equity ratio band would be 63% to 77% before forced action).

Thoughts welcome.

Regards, Newroad

I wonder how much to fuss about it, during idle moments.
There’s no assurance it will improve returns: in a trending market (steadily up or down) one would expect to lose out compared to not rebalancing; in a swinging market one could win out.
That leaves rebalancing to maintain risk level steady. If a boom takes me from 70/30 to 80/20, I have more risk but I wasn’t harmed if that risk takes me back to 70/30 or even to 60/40 (and the latter could happen even if I’d rebalanced).
But plenty take it seriously, as seen here: https://www.bogleheads.org/wiki/Rebalancing

Thanks, JohnW.

That is very helpful!

I've only skimmed thus far (and a couple of the links within the link are broken) but a cursory analysis would suggest that what I propose is reasonable. The main additional thing to consider is whether to do a forced rebalance, say, once a year - see the new (4) below. My provisional revised list looks as follows

1. Equities +/- 10%: Rebalance as soon as practical (i.e. especially in the case of a crash, wait until spreads re-tighten to acceptable levels)
2. Equities +/- 5%: Rebalance quarterly
3. New Contributions: (Partially) rebalance monthly - which is what I already do
4. Mandatory Rebalance: Once annually - this is under consideration and something which could be wrapped into the calendar Q2 or Q3 process as per (2) above
5. Otherwise: Leave alone

I am convinced that (3) is already improving my performance, but only at the margins. These investments go in free of additional charges (part of II's free monthly investing every third Wednesday) and whilst equities go up overt time, they don't typically do so in a straight line, meaning I'm buying, on average, at a better than "middle" equity vs bond price. Also, even when equities and bonds move in the same direction, as they did for much of 2022, they don't do so at the same pace - so you are buying the one with the worse recent performance (likely equities if going down) and getting the benefit of a reversal if and when it comes.

One question is whether to introduce (4) as above - as I note, it's now under consideration. My instinct is no - and to leave alone unless a rebalance is suggested by (1) or (2). Another question is the banding for (1) & (2). It might be reasonable to extend the bands to 20% and 10% respectively, i.e. force a rebalance in the case of an equity "crash" but in the case of a "correction", only do it at the quarterly boundary.

Regards, Newroad

Newroad, I think that you are overcomplicating things. All portfolios get out of balance with time. You can do a lot by selectively investing new cash, or reinvesting dividends and interest. I do not see any need to rebalance between equities and bonds or cash. They may well go their separate ways and you may be throwing money away by trying to rebalancTJH

Morning, Terry.

Perhaps you are right, but I suspect not.

"You can do a lot by selectively investing new cash, or reinvesting dividends and interest" - this is what I already do and I agree with you. It is substantively represented by (3) in my list.

"I do not see any need to rebalance between equities and bonds or cash" - I disagree. This is about risk reduction. I know there is a relatively high proportion on this forum (and seemingly a lesser proportion elsewhere) who believe in near 100% equities or similar - but more common would be some form of balanced portfolio, often with a metric which reflects age (as a proxy for when funds might be needed near-term). For my purposes, I judge this needs to happen - others are welcome to go their own way.

"They may well go their separate ways and you may be throwing money away by trying to rebalance" - this is a risk if not done using some sensible approach. In effect, this is what the OP was predominantly about. I judge transactions costs, brokers and market spreads, are the key risk from over-activity. If you mean the opportunity cost from not being 100% equities, see the point above.

What I would say is that I have tried to model the rebalancing needs in a more complex way previously, but I'm pulling back a bit on that now - and going back to my equity target percentage "North Star" alone.

Regards, Newroad

Newroad, I agree with your viewpoint on rebalancing. I think it is necessary and it's purpose is about risk management, rather than seeking a performance boost.

I tried to seek out some technical articles on the subject, but found them rather lacking. I won't reproduce the links here (I suspect many of them are redundant now). In my notes at the time I recorded that few of them added anything new to the subject, but concluded with a quote from David Swensen:

“The fundamental purpose of rebalancing lies in controlling risk, not enhancing returns.”

Personally, I have a threshold of 20% set to prompt rebalancing. Consistent with your description, this is 20% of the allocation to the asset class. So a 15% class allocation would prompt rebalancing if outside 12%-18%.

I do struggle a bit with multiple accounts (either for different family members or for different tax regimes). I try to rebalance more at the summary level and not worry too much about at an account level.

Thanks, Boots.

On the threshold question, alluded to earlier, I'm coming further around to my suggested and your actual threshold of 20% (i.e. a crash) for a forced immediate rebalance. If I do that, I would also set the quarterly threshold to 10% (i.e. a correction) to require a rebalance.

My master spreadsheet already calculates the raw information needed to make the decisions (for the six sub-portfolios) so no extra work needed there. As an aside (though this wouldn't be the basis for the calculation) I've had a quick look - for the family as a whole, we're currently 63.94% equities (25.05% bonds or bonds/cash-like and 11.02% cash).

Where I have perhaps struggled previously is what/where to measure. I used to do it at a instrument level, but the issue is, with the four that make up one of our portfolios balanced 32%/32%/24%/12% or thereabouts, it is typically the 12 one which suggests a rebalance first (and early). Hence, me simplifying and going back to the equities ration alone as the trigger (the 32+32 above). That should be more pertinent and also encourage less activity.

Regards, Newroad

When I was earning, I never bothered with re-balancing. Trying to second guess the market, incurring transaction and market spread costs, plus triggering taxation costs was not for me. Added to that, looking at various family portfolios that were professionally managed, I did comparisons between the actual outcome and what would have happened if the initial portfolio had been left untouched. The do nothing approach always came out better! There were always involuntary disposals (takeovers) and that was an opportunity to decided how to reinvest the proceeds.