Portfolio Rebalancing

Read an interesting article this morning from the economist talking through the benefits of regular rebalancing.

https://www.economist.com/finance-and-economics/2018/07/26/why-simple-rules-are-best-when-spreading-your-investment-bets

I was wondering what people thoughts/ strategies were in this area and if there were any downsides to this strategy? In particular the advantages of having (what I thought) was such a high amount of bonds in the mix for a long term strategy.

The big :open_mouth: quote for me was

‘A $1 investment in stocks in January 1926 was worth $1.81 by December 1940 (after some extreme ups and downs). Bonds did better. A dollar invested in 1926 was worth $2.08 by 1940. A buy-and-hold portfolio of 60% stocks and 40% bonds in 1926 left untouched would be worth just $1.92. But a 60-40 portfolio, rebalanced every quarter, would be worth $2.46, beating both stocks and bonds’

It doesn’t specify if this takes into account the additional fees that must currently come with rebalancing (go freetrade!) and I don’t know if market behaviours have changed significantly since the 30’s but regardless this seems to make a lot of sense. It may be obvious to those more experienced but other than to keep the risk profile the same it is something I wouldn’t have necessarily thought made such a difference!

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A very interesting article. However, the bonds are only underperforming in the current conditions due to historically lowest interest rates (IR).

From 1918 to 1940, the US IR were between 7% and 3 % (going down post war). When the IR are high, bonds always perform well, whereas stocks do not necessarily - businesses find it harder to borrow hence cannot deliver growth in performance to justify the share price growth.

You can see now the US is increasing the IR steadily, it is 2% already and does not seem like they are looking to stop, hence you could expect bonds maybe not outperforming, but certainly creeping up towards stocks’ performance in the near future.

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Like the premise of sticking to simple rules. For a lot of disciplined activity actually, simple and achievable beats complex and ambitious.

As @Vlad says, the bonds performance is in the context of a very different US government in a very different era. Can’t see US rates going up to 7% but hey, clearly the world is unpredictable.

Worth remembering as well that higher interest rate environment doesn’t just pull down stocks due to borrowing costs - there’s also a big impact on share prices from potential investors opting for cash or bonds instead.

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So I was reading this artcile
https://www.nerdwallet.com/blog/investing/millennial-retirement-fees-one-percent-half-million-savings-impact/

I wondered if someone could explain exactly what rebalancing is?

“By assembling a low-cost exchange-traded fund, or ETF, portfolio on his own and rebalancing it once a year, a millennial can retire $345,000 richer than if he uses a target-date mutual fund.”

And based on the article what would people suggest in terms on long term savings ie.
Freetrade vs Nutmeg

In simple words, rebalancing is buying/selling over- and underperforming stocks based on your investment strategy. For example, say you decide to keep 50% of your savings in company A and 50% in company B, which is how you spend your first £200 (£100 in each). However, in a year’s time you company A is worth £200 and company B is still worth £100. Overall you achieved 50% growth (exaggerated for simplicity) but your split is now 67% vs 33%. Therefore, you sell £50 of company A and buy more of company B to retain equal split.

The general rule is, the less frequent rebalancing is, the cheaper it is (cost of transaction and analytics). The reason why index trackers are low-cost is that there is very limited analysis involved - you simply copy the index, which in essence is dependent on each component’s performance. For example, if Microsoft’s weight in the S&P 500 index is 4.2%, index ETFs will ensure that 4.2% of their value is in MSFT, and so forth. The only question is how often they rebalance in case the valuations drastically change. For one ETF it could be daily, for another it could be quarterly, which will have an effect on net fees since transactions cost money.

If you need a very true representation of the market, you would probably go with an ETF that rebalances often. If you are not too concerned about it (Northern Trust also concluded that frequent rebalancing is not often beneficial), you may be better off with the one that is not too active.

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Rebalancing is periodically buying/selling in order to bring your portfolio back into line with your plan.

Eg if your plan was to have 80% stocks and 20% bonds, then once a month/quarter/year/whatever feels good you might check to see the values of your portfolio. If it’s now 84% stocks and 16% bonds, you’d sell some stocks, buy some bonds to being it back in line.

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Nutmeg and other robo-advisors are all unnecessary businesses with pointless fees. I wrote a little overview of what their fees represent and how you could easily avoid them and save a lot by investing in the ETFs directly.

Taking Nutmeg’s cheapest option into account (0.45% fee), you will pay £0.69 per week if your portfolio is above ~£8,000, and this £0.69 equates to the cost of Freetrade’s ISA, £36 per year. If your portfolio is less than £8,000 it is even more beneficial to simply stick to Freetrade’s GIA since you have no risk of tax with such a low amount. This is all exclusive of the ETF fees, which are added onto the costs outlined above.

Taking into account Freetrade’s regressive fee structure, the richer you become, the more negligible the fee becomes. I do not quite see any other provider in the UK who could offer comparable value.

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