The Investment Scientist

Portfolio rebalancing is like earning a ‘bonus’

Posted on: June 14, 2013

Rebalancing your portfolio

Rebalancing your portfolio

Recently, I visited a prospective client in New Jersey. He is currently a client with Fisher Investments, and his advisor told him never to rebalance since that involves market timing.

I have to hand it to this financial advisor for recognizing that market timing is an unproductive endeavor, but he is so wrong about rebalancing that I am compelled to write this article.

Rebalancing is not a market timing activity, it is calendar-driven or condition-driven. For instance, you may decide that you will rebalance your portfolio on January 1st of each year or whenever an asset class allocation is off by 20%.

Unlike trying to “time” the market, rebalancing has been shown to increase returns. Let me show you a very simple example.

Let’s say you only invest in two funds: a U.S. total equity asset class fund and a U.S. total bond market index fund. The symbols are DFQTX and VBMFX, respectively.

The following are their annual returns:

Michael_Chart-1If you had invested $100,000 at the beginning of 2008, equally split between DFQTX and VBMFX and never rebalanced, at the end of the 2012, you would have $123,650.

If you had rebalanced every year, you would have $128,753. The additional $5,000 plus is what economists like to call the rebalance “bonus.”

Why is there a rebalance “bonus” and why is it likely to persist?

The equity market and the bond market don’t move in tandem. In fact, many times, they move in opposite directions. When you rebalance, you take money off the asset class that has risen in value and put the money into the asset class that has fallen (or has not risen as much) in value. This is selling high and buying low.

When this is done systematically over time, it’s hard not to earn a “bonus.”

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

Twitter: @mzhuang

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