We call this a brilliant article. But have you expanded your portfolio
to include real estate?
hifting
money from winning funds into laggards is counterintuitive, even though doing
so can help reduce risk. But rebalancing has rarely been more challenging than
it is today.
The
Standard & Poor's 500-stock index is up 16% this year, and the 10-year Treasury
bond has dipped 5.2%, which means you should move money from stocks into bonds.
Uh-oh.
This is a dicey time to be plowing cash into fixed income. The Federal Reserve
has repeatedly signaled that it will dial back its policy of buying bonds to
keep interest rates low -- something that will pummel bond prices.
"I'm
usually skeptical when someone says, 'This time it's different,' but once in a
great while it is," says investment consultant Charles Ellis, author of Winning
the Loser's Game. "You really need to think twice about owning bonds
today."
So
how do you rebalance when what you're supposed to buy looks so risky? One
approach: Skip it. Jack Bogle thinks you can. The Vanguard founder has long
maintained that the value of rebalancing is overhyped.
"If
you can ignore market fluctuations along the way, it's better not to rebalance,
since you're likely to get higher returns," he says. If that seems hard to
swallow, look at the math and consider the logic behind it. Then see if you're
a candidate to follow Bogle's advice -- or whether you'd be better off
switching your eggs around.
The case for doing nothing
You
know the argument: Regularly getting your portfolio back to your ideal
stock-bond mix forces you to sell high and buy low. But over very long
stretches, the strategy is unlikely to boost your returns. In a recent study,
Bogle compared the performance of a 70% stock/30% bond portfolio that was
rebalanced annually with one that was never touched.
Are diamonds a good investment?
Over
the 187 25-year periods ending between 1826 and 2012, the rebalanced portfolio
earned a sliver less on average. In 55% of the periods, rebalancing beat doing
nothing, by an annualized 0.23%, adjusted for inflation. When rebalancing hurt
returns, the penalty was larger -- 0.43%.
Bogle
is not alone in pointing out the limits of rebalancing. A 1988 study
co-authored by Nobel Prize-winning economist William Sharpe found that
rebalancing has worked best when assets that had been performing strongly or
poorly made sharp moves back to their historical averages, such as right before
the tech crash.
But
when stocks consistently do well, a buy-and-hold strategy delivers superior
returns. "Market sentiment tends to persist, so if you're buying low, you
may not see a rebound for decades," says Christopher Jones, chief
investment officer at Financial Engines, an advisory firm founded by Sharpe.
And
by shifting into bonds now, you're almost certainly buying well before the low
is even set. With nervous investors already ditching bonds, long-term issues
have been hit hard. Vanguard Long-Term Treasury (VUSTX) has fallen 9.9% this year; the 10-year
Treasury yield was recently at .65%, vs. 1.8% in January. But that's far below
the 10-year's historical average of 4%. And when the Fed pulls back on bond
buying, prices will dive even more.
How to hack hanging tough
Sticking
with your current mix calls for a long time horizon and a strong stomach. You
have to train yourself to resist the urge to trade (think back to how you felt
in 2008).
"If
you want to sell, ask yourself who's the idiot who wants to take the other side
of your trade and why," says Meir Statman, behavioral finance professor at
Santa Clara University. It could be a value shopper like Warren Buffett.
Statman, who does not rebalance his portfolio, adds, "When the market
dips, I remind myself that being down a few thousand dollars doesn't mean I'm a
stupid person, and when the market is up, it doesn't mean I'm smart."
When
the conventional wisdom wins out
This
strategy doesn't just hinge on your temperament. You need time too. "When
markets decline, it can be violent," says investment adviser Bill
Bernstein, author of Deep Risk. "Short-term losses can be 30% to
40%." Anyone who is near retirement or already retired can't simply wait
out severe swings. For you, rebalancing remains an effective way to protect
your portfolio.
A
portfolio that's rebalanced annually tends to suffer milder one-year losses --
crucial when your investing time horizon is short and a crash hits.
"Investors
who rebalanced through the last couple of bubbles are a lot better off than those
who didn't," says emeritus Princeton economics professor Burton Malkiel,
author of A Random Walk Down Wall Street. (Both he and Ellis are on the
board of the retirement advisory service Rebalance IRA.)
What's
more, notes Charles Rotblut, vice president for the American Association of
Individual Investors, "losing less in a downturn means you're less likely
to panic and sell."
If
you must lighten up on stocks, be defensive
When
you shift your stock profits into bonds, position your portfolio for the inevitable
rate hikes ahead.
A
typical core intermediate-term bond fund holds more than 60% of its assets in
Treasuries and other government issues, which tend to be the most sensitive to
interest rate moves. Instead, favor corporate bonds, which are more closely
tied to company earnings than rates. One good choice is Vanguard
Intermediate-Term Investment Grade (VFICX).
Another
low-risk option is to move into shorter-term bond funds, says Bernstein. A bond
fund with a duration of six years -- typical for intermediate funds -- would
fall 6% if interest rates climb one percentage point. By contrast, Vanguard
Short-Term Bond (VBISX), a MONEY 70 fund, has a duration of 2.7 years; with
short-term rates up only slightly, the fund is down just 0.12% so far this
year.
If
you are investing mainly in a 401(k), however, you may lack bond options beyond
a core intermediate fund. Still, about 75% of large plans offer a stable value
fund, which performs similarly to a short-term bond fund. You can also invest
in more diverse bond funds through an IRA.
And
as long as you don't mind taking a little more risk, consider rebalancing into
a dividend-paying stock fund instead of bonds. "Given where rates are,
which do you think will be worth more in 10 years -- a high-quality company's
stock or its bond?" asks Malkiel.
Settle
on a middle ground
Rebalancing
doesn't have to be all or nothing. At Financial Engines, advisers don't move
portfolios back to target allocations frequently. Instead, they adjust based on
an analysis of long-term shifts in market conditions. "There's evidence
that rebalancing infrequently rather than often has better results," says
Jones.
As
an individual investor, you're in no position to do complex market studies, so
what's your right frequency? "Every year may be too often, since good
performance tends to persist," says Bernstein. "Every two or three
years is probably right."
And
given how hard it is to sit still through market swings, a modest rebalancing
plan even gets Bogle's approval. "For behavioral reasons," he says,
"most investors are happier if they rebalance, and that's worth something
too."
Source: cnn.com
