Rebalancing Vs doing nothing

BrockStoker

We've had some great arguments for rebalancing here in recent times, but I also hear the saying (or is it a quote?) that "the best performing portfolios are those that belong to the deceased" quite a bit.

Those seem to me to be contradictory, and I'm guessing the latter is a myth? Both can't be right surely?

Also, does anyone here find it hard to rebalance/take profits from a particular fund if that fund is doing very well? I guess that is an argument for removing emotion from the whole process?

I bought Baillie Gifford Japanese Smaller Companies B Acc just at the "right" (at least in one case it seems) times (5th May and 25th Aug last year). I know the current rally has to come to an end sooner or later, and it's fast reaching the point where I previously determined I should trim it back (the point where dealing charges become insignificant compared to the value of the transaction itself), but I can see myself hesitating to do so since I want to see how much the size of the fund will "snowball"!

It would be nice to just let it ride and hopefully see the fund hit 100 or even 200%. I know... there is no guarantee of that, but it seems much more attainable once you've climbed those first few 10s of %

At the same time I've been burnt in the past when I've bought just before a fund has shot up followed by an even greater subsequent fall soon after, so perhaps it does make sense to "bank" some of the profits in the good times?

darkidoe

I think the best rebalanacing method is what i learnt from Monevator. Choose a fixed asset allocation and try to keep the percentages roughly constant year on year by buying those assets that has done less well compared to the others over the past year and hence become a smaller part of your portfolio.

For example if you decided the Japanese smaller companies is to be 10% of your overall portfolio, but it has outperformed other funds you have and take up 20% of your portfolio at the end of the year. When you invest more the next time, buy more of your other equities to make the Japanese smaller companies 10% of your portfolio again. That way you save on selling and buying costs and saves you thinking about it too much.

I like the method. Secretly active passive investing

bowlhead99

The quote about portfolios belonging to the dead doing well is because nobody is there tinkering, trying to catch the top and bottom of a market and constantly looking out for new trendy funds to hop into which have 'had a good run' and buying more because the funds are successful and popular.

The idea of "don't tinker" doesn't mean that when you own 50% Japan Smaller and 50% UK investment grade corporate bonds, and the portfolio changes to 90% Japan Smaller and 10% bonds in a bull market, you should "let it ride" and be happy going into the next year with 90% of your assets in high risk equities and 10% in safe fixed interest investments.

If you do that, and decide to keep the 90:10 portfolio because you are greedy and want to see the equities double again, and Japan goes pop and drops 40% instead, you have destroyed your wealth by using a dumb portfolio like that. There is no point saying 'well it was only free gains anyway so I haven't lost anything', because of course you have - you've lost 40% of 90% of your portfolio. If you have previously determined that 50:50 is a good mix, then you need to fix your 90:10 'problem'. This is not tinkering - it is fixing a problem. And it has the benefit that you are selling high to buy low.

As darkidoe suggests, there is more than one way to fix an out of balance portfolio - you could sell one and buy another, or you could simply do it more gradually over time by putting 100% of your new money in the holdings that haven't grown until your portfolio is balanced again. However, that can take significant time. If it is going to take a year to 'fix' your out of whack allocations, that is a year of exposure to an out-of-balance portfolio which doesn't really fit your risk criteria, just because you wouldn't spend a £9.95 transaction fee to fix it. The cost of inaction, of not rebalancing your portfolio to meet your risk profile, could be a lot more than £9.95

See 'post of the month' "the power of the Rebalance" from a while back for an example of how periodically rebalancing a portfolio of uncorrelated funds back to their initial target allocations can produce a result which is almost as good as putting all your money in the very top performer while having a much lower level of volatility because you never have your 'eggs in one basket' from letting it ride.

LXdaddy

I think the key to rebalancing is having set your portfolio balance that you want and then having a mechanism that keeps you "close" to that balance.


You can either use periodic "new" money to do the rebalance as above or set a trigger point when you rebalance. The one I picked up (probably from monevator) was when the allocation is out by more than 5% or more than 25% of it's target. So if I have a desired allocation of 10% for a sector if that becomes less than 7.5% or more than 12.5% it's time to rebalance. If I have a sector which is intended to be 40% if it outside 35% to 45% then it's time to rebalance.


This approach avoids tinkering for every minor deviation from the desired but also prompts you to take advantage of the gains when they happen rather than hang on because "maybe it will continue".

gadgetmind

BrockStoker wrote: »

Also, does anyone here find it hard to rebalance/take profits from a particular fund if that fund is doing very well? I guess that is an argument for removing emotion from the whole process?

Yup, you automate it as much as you can. I tend to rebalance once a year, and usually in April when new money goes in.

I hit the "download" button for each portfolio (his and hers SIPPs and ISAs), copy and paste the data into my spreadsheets, and these then tell me what's under/over my target allocation. I don't always make every tweak the spreadsheet shows as I use ETFs that have trading costs, but I do most things that are over 5% out and everything that's in double figures.

Due to new money and dividend reinvestment, there aren't usually a lot of cases where trimming is needed, but when it's needed I just do it.

bowlhead99

Removing emotion is important. Otherwise you will find that you can construct a passionate argument to ignore pretty much any sensible rebalance change:

"I've heard good things this sector recently so want to hold onto it until it goes up another 5%" ;

"these funds have had a tough time, no point throwing good money after bad";

"i took some money out of my portfolio to buy a car so as my overall total is smaller the theory says I need to reduce the holdings in this sector which is now overweight- but it's showing a loss and I don't want to realise a loss because a loss isn't real until you sell, I'll sell it when it breaks even"...

Also if you allow yourself to come up with silly little arguments here and there about not rebalancing, but then "follow the rules" and do it anyway, if you make a loss or miss more gain over the next six months, you'll think back to those arguments and begin to doubt your sensible plans. So staying dispassionate is important.

If you can ignore the temptation to look in every day, you might be in the fortunate situation that you don't quite know how much you have in every fund going into your annual or semi annual rebalance review, and can decide what proportions you want as your target without distraction. So then it is just a matter of seeing how far away your "actual" is from your "target" and letting the spreadsheet tell you what to buy and sell.

Once you've decided what proportions make sense to hold now (ignoring the numbers that you actually have in the portfolio right now), the maths to find out how to get to the target percentage from the current holdings plus £x of cash is only junior school level. So you might find it helps to give the job to your spouse or kids to do and call the funds Fund A, Fund B etc. Check the maths and make the trades. Then there is no temptation to hold on to your "favourite" fund "just to see how it goes".

As Gadget says if you have healthy chunks of new money to deploy, you will find much of the "fixing" to target can be done by spending new money instead of selling out of stuff.

gadgetmind

Oh, and rebalancing time is also a good opportunity to understand whether you've got too many holdings. If rebalancing is a chore, then yes you have!

BrockStoker

Thanks for the replies guys. Unfortunately I don't have new money to go into the portfolio, but at least my portfolio is relatively simple to rebalance (300k split between 8 funds), though I may yet ditch one or two funds which I don't think I need.

JohnRo

The quote is supposed to come from a Fidelity study and compares with the average retail investor, whatever that is, but seems a bit of an internet myth AFAIK, I'm not sure anyone has a source for the claim but it has been the topic of much debate regardless.

For a start, if the premise does actually exist, the people it refers to may just have had a stronger bias towards equities that the average (which have been shown to give the best overall historic returns in a long enough time frame) because they weren't in a position, being deceased, to shift the weighting towards the perceived safety and typically lower return of bonds as they neared retirement. Also for the same reason they wouldn't be able to fiddle about with, mistime, change direction or panic themselves out of a negative portfolio.

Another theory is that the timing of the mysterious "study" simply coincided with the strongest bull run in modern history and flattered to deceive.

Personally I'm convinced asset allocations and "dumb" mechanical rebalancing is the way to go, even when the inevitable market gyrations might make you question the validity and wisdom of it.

bowlhead99

BrockStoker wrote: »

Thanks for the replies guys. Unfortunately I don't have new money to go into the portfolio, but at least my portfolio is relatively simple to rebalance (300k split between 8 funds), though I may yet ditch one or two funds which I don't think I need.

FWIW, I was looking at my mum's ISA earlier to rebalance it as it's a whole mix of funds which had built up over time from a couple of different places. There were 16 holdings altogether which I considered reducing in number but I'll kick that can down the road until she puts more money in this summer.

It helped to bucket the investments together by rough "type" to gauge the general exposure before doing the look-throughs via morningstar/ trustnet. We had (my 7 headings)

"Bonds":
A strategic bond fund

"Property":
A generalist UK PAIF and a single sector UK REIT

"Lower volatility mixed asset"
A multi strategy/ absolute return fund and an investment trust (Personal Assets Trust)

"Higher equities mixed asset"
Vanguard LS 80 and an investment trust (RIT Capital Partners)

"Developed market mainstream equities"
A global fund, two UK funds, a Europe ex-UK fund, an Asia-inc-Japan fund, a US fund

"Emerging market mainstream equities"
An investment trust (Templeton Emerging Markets)

"Specialist equities"
A frontier markets IT (Advance) and a global infrastructure fund

The portfolio should probably be cut back to simplify it as there's no real need for 16 funds but at the end of the day after some tweaks it's not horrendously out of whack with where it should be in terms of overall proportions and some sort of balanced exposure.

Where there are some gaps or overweights I took a view in aggregate with my Dad's holdings - which I also put in the same 7 broad "buckets". I've culled a few but he's also now got 16 holdings which are more than he needs, some of which are common with Mum and some are not.

I've taken a view that even though they manage their money as a couple, they each need exposure across the sectors because if he had all the equities and she had all the bonds, it would be completely impractical to rebalance effectively while preserving the ISA wrappers. But within categories, if she has the UK property and he has the international property, or his "specialist" theme is microcap and hers are frontier and infrastructure, it probably works well enough without over-thinking or trying to make each of them literally take a bit of everything.

gadgetmind

bowlhead99 wrote: »

The portfolio should probably be cut back to simplify it as there's no real need for 16 funds but at the end of the day after some tweaks it's not horrendously out of whack with where it should be in terms of overall proportions and some sort of balanced exposure.

It's certainly multi-asset and doesn't seem to have any real crazies.

I've taken a view that even though they manage their money as a couple, they each need exposure across the sectors because if he had all the equities and she had all the bonds, it would be completely impractical to rebalance effectively while preserving the ISA wrappers. But within categories, if she has the UK property and he has the international property, or his "specialist" theme is microcap and hers are frontier and infrastructure, it probably works well enough without over-thinking or trying to make each of them literally take a bit of everything.

That's pretty much the approach I take across three pensions, and two ISAs. Our unwrapped holdings are more of a special case but TBH the new ISA allowances mean that I'm actually dismantling these currently though CGT is obviously a brake.