One thing that you can be sure of at this time of year is that there will be plenty of articles encouraging investors to rebalance their portfolios. This is an interesting trend, considering the damage implications it could have for any portfolio that is managed on a 12-month basis.
The folly of rebalancing
The idea behind portfolio rebalancing is that you adjust your portfolio for the current trading environment and the outlook for the year ahead.
There are several obvious problems with this approach.
First of all, as we know from many different studies and as any seasoned investor will know, it is impossible to tell what will happen in the markets over the next 12 months, from a macroeconomic perspective. This is also true from an asset-up perspective. I have not done any research on the topic, but I would be willing to bet that heading into 2018 there were very few analysts that were recommending investors go to cash, but this has been the asset class that has produced the best performance for investors so far (and considering the state of the markets at the time of writing, it will continue to do so).
The second obvious drawback to this approach is that it encourages short-termism. Focusing on what might happen over the next 12 months ignores long-term market trends and is particularly damaging in volatile markets.
Third, there are fees to consider. One of the reasons why asset managers recommend rebalancing is because it encourages trading. Trading produces fees, which is good for asset managers but bad news for investor returns. This is another reason why it is probably sensible to avoid rebalancing every 12 months.
On this topic, there is an interesting story in Joel Greenblatt (Trades, Portfolio)'s book, "The Big Secret for the Small Investor" (2011) that investors should consider. He described the findings in a recent speech at the Value Invest New York conference:
"In the book, I looked at several studies including the performance of the best mutual fund over the period 2000 to 2010. During this decade, the best long only equity mutual fund returned around 18% per year, compared to the market which was flat. The average investor in the mutual fund lost 11% a year on a time-weighted basis. The way that they did it is that after the market went up, people piled in. After the market went down, people piled out. After the fund outperformed, people piled in. After the fund underperformed, people piled out. That's how they turned the 18% analyzed gain into 11% dollar-weighted losses."
The simple takeaway from this data he concludes is that it is better for investors to stick with their strategy, and not try to time the market and jump in and out of assets.
These are just some thoughts on the topic of rebalancing. Whether you decide to rebalance your portfolio every 12 months, six months or with a longer-term horizon, is really up to you. Nevertheless, it is always important to consider the risks and rewards of taking investment actions, including rebalancing before doing so. Yes, your portfolio might look better for the current environment, but we as investors don't know how much longer the current environment is going to persist.
You don't need to look hard to find plenty of evidence to support the conclusion that most investors are terrible at timing the market and picking assets in the short term.
Conclusion
With this being the case, it seems to me that rebalancing is a waste of time and effort.
Most of the data we have today shows that deciding on investment strategy and sticking through it through thick and thin is the best way to increase wealth over the long term. Rebalancing your portfolio every 12 months seems like a quick way to make sure you are going backward.
Disclosure: The author owns no share mentioned.
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