I would like to start a discussion on re-balancing. It seems that re-balancing involves two parts, re-balancing between your stock/bond allocation (for example 60/40 split), and re-balancing your stock allocation (large cap vs. small cap vs. international, etc). The main reason for re-balancing is to reduce risk (so you don’t run out of money before you do) or increase your investment return (so your withdraw rate can be a little bigger), which are often at odds with one another. Let’s start with stock/bond allocation. What you mostly see on the internet and from investment firms is you are supposed to re-balance ever year, even quarterly. Where did that come from? It’s not really based on anything. My guess it’s from investment firms that will make money on clients re-balancing and paying for the transactions. Looking at work published by Campbell Harvey 2014 (Click on open PDR in browser: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2488552 ) and Michael H. McClung 2015, re-balancing less often is better in terms of increasing your total returns. If safety is your main concern, then re-balance more often as explained by Kitces: https://www.kitces.com/blog/how-rebalancing-usually-reduces-long-term-returns-but-is-good-risk-management-anyway/
If you had an asset allocation that was 50% stock/50% bond at the outset of the most recent market rally--which stretches back to March 9, 2009, and did not re-balance, your asset allocation by this summer would be about 75% stocks/25% bonds. By any reasonable standard, you should have re-balanced a long time ago to cut down your portfolio's equity weighting in an effort to reduce risk in your portfolio before the market does it for you. However, right now you would be rich!
I like what McClung has come up with. Start with whatever stock/bond allocations you want (within reason) say 60/40. You would take money out of your bond allocation to live on. The only time you would re-balance is when your stock valuation increased by 20%. You would then sell the increase and buy more bonds. The stocks you would sell would be used to return your stock allocation (large cap vs. small cap vs. international, etc.) to their starting position. This way you would never have to buy stocks ever again and never have to worry about selling low in a down market. With a 60/40 allocation and a 4% withdraw rate, your money will not run out (30 year retirement) based on historical (backtesting) simulations.
Thoughts??
Good point to bring up!
You can eliminate one type of rebalancing you mention by simply holding a total US stock market ETF like VTI. Poof, done. No more worrying about your spread between large-caps, small-caps, value, growth, tech, etc. You own it all. It works and is what's recommended by folks like Warren Buffet and Vanguard. Take all the guesswork and stress out of that part. I compliment that with a total international ETF in the equity portion of my clients' asset allocation. Simple, *very* low cost, easy to understand and manage - very important for my clients. They can fire me when they're comfortable and want to drive, as I teach them how to do it.
On the second rebalancing - to keep your asset allocation (AA) where you're comfortable, be careful. Rebalancing in brokerage accounts has tax considerations. You're realizing those capital gains so make sure you know what you're doing. In traditional retirement accounts (IRA, 401k/403b/457, etc) you can rebalance all you like. But again, don't get too neurotic. One guideline i use for clients is to rebalance for them if the AA strays 5% from their target. Usually once a year, unless I see some big market event, then I jump in and get them fixed up, if circumstances determine it's prudent (tax and other factors considered). Roboadvisors will do this for you, if you trust the algorithms (didn't work out well for those 787 Max passengers...). You're right though, some brokers or advisors will rebalance often as it can be profitable for them (but bad for clients).
As well, make sure your asset allocation (equities/stocks to bonds/fixed income) is aligned with not only your income needs and time horizon, but *your* comfort zone, so you're not stressed during changing market conditions. I use a cool product called Riskalyze with my clients to measure this. It's really useful when (as is often the case) one person in a relationship is very risk averse, and the other isn't. We get them both to a place of comfort. It's a beautiful thing 🙂
Taxable accounts definitely need more care then retirement accounts. Fortunately, long term capital gains (LTCG) are based on Taxable income, not adjusted gross income (AGI). For couples filing jointly, the 0% LTCG tax rate goes from $0 to $80,800. As the name implies, LTGC are based on the gains your investment made. For example, if you sold your equities for $150,000, but it originally cost you $60,000 to buy, your taxable amount is $90,000. You then subtract your standard deduction (if you are not itemizing) of $25,100 and get $64,900 taxable income. You pay $0 in Federal taxes. State taxes is another matter. You could then withdraw $15,900 from an IRA, pay 10% Fed tax on that amount ($1,590) and still pay $0 Fed tax on your LTCG. If you have less LTCGs I would still withdraw from my IRA up to the top of the 12% tax bracket (as long as your taxable income remains below $80,800) Do it now because the 12% bracket goes up to 15% starting in 2026. If you put money into a Health Saving Account your taxable income (as well as AGI) goes down further. Of course this assumes you are not getting Social Security, pensions, etc., that would add a little complexity.
holding a total US stock market ETF like VTI. Poof, done. No more worrying about your spread between large-caps, small-caps, value, growth, tech, etc. You own it all. It works and is what's recommended by folks like Warren Buffet and Vanguard. Take all the guesswork and stress out of that part.
OK, it's hardly surprising that Vanguard recommends its own ETF, as well as Buffet, given that Berkshire Hathaway is the 8th largest holding in that ETF. If you're not concerned about the market's heavy reliance on tech (27% of VTI's holdings), you surely are getting the convenience of one-stop shopping. But I don't see retirement funds as "set it and forget it" resources -- it's important to watch your basket, whether it's one or multiple baskets. I prefer McClung's various baskets, which leaven the portfolio with emerging markets, small and mid caps, REITs, as well as the usual suspects in value funds/ETFs.
Peter
What beat the S&P 500 over the past three decades? Doing nothing:
Very interesting analysis. Create your own version of the S&P 500 index, then just let it go, meaning, if a stock is delisted, sell it and just keep the cash. Do not add the new company. Do not do any re-balancing. Take away from article:
- Don’t insist on being fully invested at all times. A little extra cash, gradually amassed, can cushion the blows and is available to deploy as needed at the end of a long time horizon. It also can nicely complement a strategy of letting winners run, as it acts as a counterweight to the additional concentration at the top of the portfolio.
- Avoid equating success with particular buy and sell decisions. The Do Nothing Portfolio didn’t rush to replace one delisted stock with the new kid on the block. It let the cash build, biding its time. In general, the fewer decisions we have to make, the better. And this seemed to hold true for even seemingly mundane choices like whether to continue holding 500 stocks in the portfolio or making do with fewer.
- Acknowledge the power of letting winners run. No doubt, this won’t suit everyone, in particular those who feel squeamish about having a big share of their portfolio tied up in a handful of names. But the Do Nothing Portfolio owed at least some of its success to leaving its biggest gainers alone, notwithstanding conventional notions of risk management.
- Leave intuition at the door. The responsible voice in our head tells us that a strategy of doing nothing can’t possibly work. Yet, markets repeatedly upend our expectations, which we often form by attempting to decode recent events and their future implications. That’s even true of committees making stock selections for the indexes they oversee. Patience and humility beat action and good intentions.
For me this means re-balancing generally is not necessary (within reason). It is used to control your level of risk, not maximize returns. Letting winners run is momentum investing, something that Monty Carlo does not handle very well at all.
I too like McClung's work, not so much on the number of baskets he uses, but the fact that he recommends not re-balancing your stock holdings until they have gone up 20%, sell the 20% and put into bonds. Live off of the bonds. So you don't have to every again buy stocks.
