Tuesday, 12 February 2008

Another Advocate of Infrequent Portfolio Rebalancing

For those who believe in an asset allocation investment approach with periodic rebalancing back to target percentages, here's more evidence that less often, specifically only every four years or so, is better. I've discovered that financial planner and author Jim Otar had independently reached the same conclusion as academic researchers David Smith and William Desormeau, whose findings I had written about in December in My Rebalancing Policy Refined. Otar used US data and found that rebalancing every four years produced better results in a retirement portfolio - see his paper Optimizing Rebalancing in Retirement Portfolios. Otar found that rebalancing only every four years, as opposed to once a year, was especially important in secular bull or bear markets, in either maximizing the upward benefit of multiple years of good returns, or in minimizing the downward losses in the other directions. The latter effect was critical in helping to avoid what retirees fear most - running out of money before death.

Otar based his four-year cycle on the US Presidential cycle, doing the rebalancing at the completion of each cycle. The Smith and Desormeau article did not study the US Presidential cycle but it did look at the Federal Reserve Monetary Policy as reflective of expansion and contraction of the business cycle and found that coordinating rebalancing with changes in Fed policy (i.e. whether it goes from rate hikes to cuts or vice versa) produced the best results. Do Fed policy changes correspond to the US Presidential cycle and therefore the two sets of research are just expressing the same forces at work? Whatever that answer, both researchers say four-year long waits between rebalancing is better and it appears the reason is that one is therefore able to take advantage of multi-year bull markets or minimize the damage of bear markets.


Michael James said...

It makes sense that infrequent rebalancing would give higher returns than frequent rebalancing. In the absense of any leverage, stocks give better returns than bonds even taking into account volatility. The higher the percentage of stocks, the higher the expected return. Infrequent rebalancing amounts to letting stocks grow to comprise a higher percentage of the protfolio before rebalancing. The infrequently rebalanced portfolio will have a higher average percentage of stocks over time, and therefore is expected to give higher returns over the long run.

Even higher expected returns come from the never-rebalanced portfolio.

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