My ‘problem’ is that I seem to see everything as through a pair of glasses that somebody has stepped on – cracking the thick glass lenses, but not quite breaking them; case in point – Rick says:

Consider two cases in the first you rebalance in the second you don’t:

Rebalancing:

Stocks Bonds Total Comment
50K 50K 100K Initial conditions
25K 50K 75K right after market crash
37.5K 37.5K 75K After rebalancing
75K 37.5K 112.5K Right after market recovery
56.25K 56.25K 112.5K After rebalancing

No Rebalancing:

Stocks Bonds Total Comment
50K 50K 100K Initial conditions
25K 50K 75K right after market crash
50K 50K 100K Right after market recovery

Note rebalancing earned an extra $12.5K over doing nothing, it doesn’t compare to perfect market timing but there was no crystal ball required! Jeff pointed out rebalancing maintains the risk level. Was it less risky to hold half stocks half bonds? Yes, in the 50% market crash there was only 25K in losses rather than a 50K loss.

What if the order was different?

Rebalancing:
Stocks Bonds Total Comment
50K 50K 100K Initial conditions
75K 50K 125K Market rises 50%
62.5K 62.5K 125K Rebalance
31.25K 62.5K 93.75K Market drops 50%
46.9K 46.9K 125K Rebalance

No Rebalancing:
Stocks Bonds Total Comment
50K 50K 100K Initial conditions
75K 50K 125K Market rises 50%
37.5K 50K 87.5K Market drops 50%

Again rebalancing helps prevent losses over doing nothing. If you are invested in more than one asset class you should rebalance. We all know that there is no such thing as a free lunch though… What is the down side?

By allocating 50% bonds 50% stocks you only get half the superior stock returns if the market is steadily going up. Rebalancing reduces risk at the cost of returns in the good years. The good years actually do outnumber the bad, even though it doesn’t seem like it right now! If you can withstand the risk you should keep a large percentage in stocks. I’m young enough that I don’t have a large % of bonds- and it sucks to take the full losses. However, I’m willing to risk it now for the full gains and I’m glad I get to buy shares at a steep discount now. As I get older I will be increasing the % of bonds that I hold and will be rebalancing.

I ‘read’ the numbers, but I ‘see’ something totally different … something that Rick sees too, because he covers it in his closing comments:

The problem with ‘numbers’ is that they don’t reflect real life.

The market changes: it doesn’t reverse then recover with all ‘vital signs’ the same as they were before!

So, you are in constant ‘motion’ as bonds go up one day, stocks down the next (with sub-moves within the markets such that overseas funds are up and US funds down), and so on ….

Before we do any of this, we need to revisit our objective … why are we doing all of this in the first place?

You see, the key ‘number’ is in fact your Number and if moving half your net worth into Bonds to ‘avoid risk’ stops you from achieving your Number, why do it at all?

A simpler solution is to be 100% invested in stocks (or a suitable alternative) and hold for the long-term.

Warren Buffett is … George Soros is … I am [AJC: Well, almost 100% in real-estate with cash on the sidelines waiting for the next ‘deals’ to come along … although, I will also put some in stocks and ventures ‘for fun’].

Why?

When studies like the Dalbar Study show 11.9% 20 year returns, and others show absolutely NO 30 year periods EVER with less than an 8% compounded return in the stock market, why would you do anything else?

Of course, if your expertise is in real-estate, buying businesses, or Egyptian artifacts, I am sure that similar studies can show their benefits over 15 – 30 years, as well …

… the key is to find something that produces income that:

1. Tends to rise with inflation, and

2. You can leverage (borrow) to buy into

That way, if inflation is > 0% (as it surely will over 20 to 30 years), your return increases disproportionately (in YOUR favor, assuming that your income from the investment eventually covers your mortgage and other holding costs).

A closing note:

If rebalancing is the right thing to do, why is Warren Buffett – who was previously invested 100% in bonds – for the first time in 40+ years of investing, moving his entire personal net worth into the stock market right now?

The answer, of course, is simple: he sees that American Business is extremely undervalued right now … and, is happy to ‘rebalance’ his portfolio 100% away from bonds and 100% to stocks.

This is not really rebalancing at all: this is putting your money where the best value (hence, best long-term returns) are to be found.

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