One of the benefits of maintaining a constant asset allocation is that it forces the investor to buy low and sell high. However, this only works if investors actually do the rebalancing when the asset mix is off.
In a few places now I’ve seen comments from an investor who failed to rebalance during the lowest stock prices a year ago, but that “this is okay because my allocation percentages have almost come back in line.” Unfortunately, this investor has missed the opportunity to profit from rebalancing during the period when stocks went on sale.
To illustrate what I mean, let’s consider an example. As of the first trading day in July 2008, two investors, Adam and Beth each had $100,000 in bonds and $100,000 in the Canadian large-cap index exchange-traded fund XIU. Their intent was to maintain this 50/50 split.
However, Adam didn’t do any rebalancing, preferring to think about anything else other than falling stock values. On the other hand, Beth checked prices on the first trading day each week and rebalanced if the allocation got further out of kilter than 55/45.
Let’s compare their results. To simplify the comparison, we’ll assume that the bonds remained flat and ignore the XIU dividends. The idea is to just see what effect the rebalancing would have.
Adam just rode XIU up and down throughout this volatile period from a starting price of $19.94 per unit to $17.88 per unit.
Adam’s portfolio today:
Beth rebalanced three times:
2008 Sep. 29: Bought $10,900 XIU at $15.59
2008 Nov. 17: Bought $10,500 XIU at $11.90
2009 May 4: Sold $11,000 XIU at $15.23
Beth’s Portfolio today:
Trading just 3 days over nearly 2 years, Beth has come out ahead of Adam by about $4900 using a purely mechanical system requiring no judgement. This is more than enough to cover trading costs. Even if the savings were in taxable accounts, Beth would come out ahead.
Some investors choose not to rebalance ever, and this can be a reasonable approach. However, having a rebalancing strategy, but abandoning it when “things look scary” is just another form of following the crowd.