Charleston Financial Advisors - Fee-Only Financial Planning, Asset Management, Charleston, SC

Words of Wisdom

Words of Wisdom

The Value of Rebalancing

The recent fall in equity prices has led many to question the value of systematic rebalancing. Right now it seems like throwing good money after bad.  However, we believe that systematic rebalancing (selling the best performing asset classes and buying the worst performing) helps performance in the long term.  As evidence of this I would like to summarize a study by Craig L Israelsen, Ph.D., a professor at Brigham Young University.  This study was published in an article in the February 2009 issue of Financial Planning magazine ( 

The study analyses two portfolios invested in the same asset classes represented by their respective indexes.  The asset classes are Large U.S. Equities, Small U.S. Equity, Non-U.S. Equity, U.S. Bonds, Cash, Real Estate Investment Trusts, and Commodities.  Each portfolio had an initial investment of $10,000 on January 1st, 1970 divided evenly between the asset classes.  One portfolio rebalanced annually and the other portfolio never rebalanced.  It was a pure “buy and hold” strategy.  By October 31, 2008 the portfolio that rebalanced annually was worth $468,929.  The portfolio that never rebalanced was worth $364,835.  That’s a difference of $104,094 or .72% a year.  

Right now Spring 2009 it’s scary to be selling fixed income and buying equities.  Uncertainty about the future has everybody on edge.  If we all knew where the economy was going, there would not be such wild swings in the indexes and equities would not be trading at such a discount.  For investing, this is called the market timing problem.  Market timers have to be right twice; when they sell and when they buy.  An allocation with systematic rebalancing confronts this issue and hedges market timing risk.  When there is a gain in one asset class relative to another, you are selling some of it.  When there is a loss, you are buying it. 

For the portfolio that rebalanced annually, the ending values in bonds and cash were significantly larger than for the portfolio that didn’t rebalance.  This means that more of the portfolio’s value is in less risky asset classes which brings down the risk of the portfolio.  This aspect has enormous implications for older investors in environments similar to today.  Essentially, by systematically rebalancing you are increasing your return and decreasing your risk over the long haul.