Just Do It.

Last week, Nathan emphasized the importance of rebalancing your portfolio in his blog post–which was awesomely titled “The Playoff Beard” and reflected his love for the Washington Capitals. I don’t have a passion for the Caps (or beards), but when I read Nathan’s post, it did remind me of a great research paper that Vanguard just released on rebalancing (which I am passionate about…).

Most of us have heard of the importance of rebalancing, but half the time we forget, or we let emotions get in our way. We just can’t sell the stuff that is going up to buy the stuff that is going down (which is often the case when we rebalance!). So, most financial advisors tell their clients to just set a regular routine schedule (i.e. monthly, quarterly, semi-annually…) and rebalance on predetermined dates.

PortfolioOptimizationAndRebalancing

Meanwhile, other advisors have been promoting rebalancing only when your portfolio drifts too far away from the predetermined allocation. For example, your portfolio has a 50% equity allocation—a drift rebalance would occur only when the actual equity allocation moves a predetermined percentage away from the target (i.e. 5% or 10%). So the 10% drift band “rebalancer” would only rebalance their portfolio when the equity allocation went above 60% or below 40%. This sounds great in theory, but this approach means you have to be watching your portfolio constantly to know when you are above or below your target.

All of these approaches are wonderful, but the argument over which is best drowns out the overriding point that Vanguard determined: JUST DO IT.

In case you don’t enjoy reading white papers on the technicalities of rebalancing, the summary of Vanguard’s report is that it’s better to rebalance your portfolio than to not. From 1926 through 2009, whether you rebalanced monthly, quarterly, or annually (and with drift bands or without), a balanced portfolio (half stocks, half bonds) would have earned between 8.5% to 8.7%. Not a huge difference!

But, what Vanguard did notice was that there was a very significant difference between all of the rebalanced portfolios, regardless of the methodology used, and the portfolio that was never rebalanced. For the portfolio that was never rebalanced, the risk was significantly higher…meaning the chances of great loss were magnified. And, the set-it-and-forget-it portfolios also had poorer risk adjusted returns.

So, as Nathan emphasized last week, the most important thing to remember about rebalancing is that you just need to do it!

Just Do It.
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