At the Retirement Advisor, we are ultimately concerned with helping our subscribers maximize their portfolio returns while minimizing risk. We regularly cover topics to educate our subscribers on how to best manage their portfolios. One such topic is portfolio rebalancing.
Buy Low and Sell High With Rebalancing
Portfolio rebalancing brings your different asset classes back to your target asset allocation after a significant change in one or all. Rebalancing means you sell some of what has done well (sell high) to buy some more of what has lagged (buy low.)
In a volatile market, you can get added return over buy and hold from rebalancing but the main reason we rebalance is to control risk. Let’s use a simple, balanced, two-asset class, $100,000 portfolio made of the total stock market and money market funds from Vanguard (VTSMX & VMMXX) to illustrate.
You start with $100,000:
• $50,000 in VTSMX and $50,000 in VMMXX
Let’s assume the stock market gains 100% over the next ten years (average annual return of 7.2% per year) while the money fund gains 5% per year.
After ten years without rebalancing you have $163,814:
• $100,000 in VTSMX and $63,814 in VMMXX
You rebalance to control risks from bear markets. If the market were drop 50%, as it did in the 2000 to 2002 bear market, then after two more years you would have roughly
$120,355, a total decline of 27%:
• $50,000 in VTSMX and $70,355 in VMMXX
If you have 20 years before you retire for the higher returns of the stock market to make this loss up for you, then you simply wait. But if you are retired, that 27% is a painful decline.
Compare that 27% portfolio decline to a portfolio that grew to $163,814 with regular rebalancing such that it started the two year bear market with
• $81,902 in VTSMX and $81,902 in VMMXX
After the two year bear market, this would become $131,248 a decline of “only” 20% vs. 27% without rebalancing:
• $40,951 in VTSMX and $90,297 in VMMXX
Rebalancing forces you to sell some of your winners to buy more of your losers. In our case, we sold some of the more risky stocks to increase our lower risk cash. For
many of our subscribers, even a 20% portfolio loss is too painful so we offer model portfolios two and three with thirty and zero percent allocated to equities, respectively.
Finally, bonds can do well when stocks do poorly so your total portfolio loss is usually less than shown in our example that used a money fund with constant returns. For this reason, we use bond funds in our model portfolios.
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To learn how to subscribe to The Retirement Advisor Newsletter, visit our web site where you can download a free issue with instructions on how to subscribe. Subscribers are able to obtain all of our back issues at no extra cost.
Buy Low and Sell High With Rebalancing
Portfolio rebalancing brings your different asset classes back to your target asset allocation after a significant change in one or all. Rebalancing means you sell some of what has done well (sell high) to buy some more of what has lagged (buy low.)
In a volatile market, you can get added return over buy and hold from rebalancing but the main reason we rebalance is to control risk. Let’s use a simple, balanced, two-asset class, $100,000 portfolio made of the total stock market and money market funds from Vanguard (VTSMX & VMMXX) to illustrate.
You start with $100,000:
• $50,000 in VTSMX and $50,000 in VMMXX
Let’s assume the stock market gains 100% over the next ten years (average annual return of 7.2% per year) while the money fund gains 5% per year.
After ten years without rebalancing you have $163,814:
• $100,000 in VTSMX and $63,814 in VMMXX
You rebalance to control risks from bear markets. If the market were drop 50%, as it did in the 2000 to 2002 bear market, then after two more years you would have roughly
$120,355, a total decline of 27%:
• $50,000 in VTSMX and $70,355 in VMMXX
If you have 20 years before you retire for the higher returns of the stock market to make this loss up for you, then you simply wait. But if you are retired, that 27% is a painful decline.
Compare that 27% portfolio decline to a portfolio that grew to $163,814 with regular rebalancing such that it started the two year bear market with
• $81,902 in VTSMX and $81,902 in VMMXX
After the two year bear market, this would become $131,248 a decline of “only” 20% vs. 27% without rebalancing:
• $40,951 in VTSMX and $90,297 in VMMXX
Rebalancing forces you to sell some of your winners to buy more of your losers. In our case, we sold some of the more risky stocks to increase our lower risk cash. For
many of our subscribers, even a 20% portfolio loss is too painful so we offer model portfolios two and three with thirty and zero percent allocated to equities, respectively.
Finally, bonds can do well when stocks do poorly so your total portfolio loss is usually less than shown in our example that used a money fund with constant returns. For this reason, we use bond funds in our model portfolios.
* * *
To learn how to subscribe to The Retirement Advisor Newsletter, visit our web site where you can download a free issue with instructions on how to subscribe. Subscribers are able to obtain all of our back issues at no extra cost.
| The Retirement Advisor Portfolios | Dollar Value on 9/30/09 | Change |
| Model Portfolio 1 | $208,276 | 4.1% |
| Model Portfolio 2 | $219,741 | 9.9% |
| Model Portfolio 3 | $235,541 | 17.8% |
| DJIA 12,501.52 on 1/1/2007 | $9,712 | (24.0%) |
| S&P500 1,418.30 on 1/1/2007 | $1,057.08 | (28.0%) |
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