Comments on: Should Portfolio Rebalancing Be Considered Market Timing?

By: Bryan

Bryan — Sat, 19 Jul 2008 20:56:55 +0000

Rebalancing works great in moderate markets, but what about giant bubble markets like what we have seen with Real Estate and now energy? When an educated person knows in their heart that things are about to go really bad (the Sheeple are all “in the market”) What do we do then?

Put the rebalanced strategy on hold and go to cash or is there another strategy that works that is not so severe? These bubbles tend to last longer than we think they will and the drop is quick and severe, so mechanical strategies may not hold out for these situation.

Bubble markets are obvious and hard to miss. Some sort of timing strategy makes sense for these.

Those that track markets understand when the implications when a market is well beyond the normal range. Has anyone run across research on bubbles? Do you follow a different strategy change for these special market conditions?

Thanks!
-Bryan

By: Adam

Adam — Wed, 07 May 2008 14:40:26 +0000

I prefer to rebalance (my 401k) by adjusting my contribution allocations for the first couple of months of the year. On the first of the year I take a snap shot of my portfolio and assume everything will remain frozen there. I then calculate the balanced amount for each fund assuming I can make a lump sum contribution to avoid selling any shares. I then adjust my contribution allocation over the next several pay periods to meat this balanced portfolio, while ignoring any changes since my snapshot. When I have finished with the balanceing I return to allocating my contributions with the same distribution as I would like to keep in my portfolio.

Since either this method or the standard buy and sell method involve basing decisions on the market at a certain point in time, you are technically timing the market. In my opinion, market timing involves lump sum investing with the goal of buy low and sell high, whereas if you are making regular contributions in a set allocation you are time-averaging instead of market timing even though you are trying to maintain a set portfolio allocation over time.

By: RC

RC — Wed, 07 May 2008 04:47:57 +0000

I think Scott hit the nail on the head, and the first thing I though of when I read this post was Benjamin Graham. There is an interview published shortly before his death where he touches on this issue, a reprint can be found at http://www.bylo.org/bgraham76.html, I posted my thoughts on this interview and my thought on rebalancing as Scott has described Graham’s position was that it isn’t market timing. You are locking in your gains by rebalancing, not trying to maximize them by timing the market.

By: augie

augie — Tue, 06 May 2008 19:17:44 +0000

Don’t finish the rest of the book – this author’s statement is hogwash. Market timing is about expected return, looking at the heart of the distribution of potential outcomes. Rebalancing is about minimizing risk – looking at the left-sided tail of the distribution.

By: ciwood

ciwood — Tue, 06 May 2008 17:18:17 +0000

Market timing is betting you know what the market is going to do. Reallocating is admitting that you do not know what the market is going to do and you are willing to reduce potential future gains in return for less volatility. Reallocating is the only way I know to consistently sell high and buy low. Believe me, I have tried every other way!!!

By: Scott

Scott — Tue, 06 May 2008 17:04:11 +0000

I don’t think that portfolio rebalancing a portfolio on a quarterly or annual basis is market timing. Rebalancing on a each month is probably market timing.

I think the purpose of rebalancing is to realign your portfolio with your risk tolerance and to preserve gains from the bond or stock markets. Failure to rebalance could expose an investor to a higher amount of risk than they’re comfortable with. Benjamin Graham’s ‘The Intelligent Investor’ does an excellent job of describing why rebalancing a portfolio composed of bond & stock holdings is important. Since these markets usually move in opposite directions, taking gains from a bull stock market and placing them in relatively cheap bonds will help preserve the stock gains when the stock market falls and bond market rises. The opposite is also true. So, rebalancing quarterly or semi-annually ensures that you’ll not have to time the sale of your holdings from a bull market because you’ve been dollar-cost averaging their sale for months or years. It’s the exact opposite of market timing if done with discipline and an indifference to the state of the market.

By: steve

steve — Tue, 06 May 2008 12:50:41 +0000

In response to Sam and Ian, while the 70%/30% may be contrived in this scenario, I believe there is a method for determining the optimal (theoretically at least) portfolio allocation using Modern Portfolio Theory. Based on your risk tolerance (max allowable standard deviation in yearly returns), you can select a portfolio that optimizes your ROR and minimizes your risk. I am not an expert on MPT, but check out this link to get an overview and some examples. It gets a little math and statistics intensive, but who doesn’t love math!!

http://www.moneychimp.com/articles/risk/riskintro.htm

By: marylandterps

marylandterps — Mon, 05 May 2008 23:53:49 +0000

Yes this is market timing, and buying stocks and reselling them 5 years or 10 years later is also market timing (for example, if you need the money for college or a down payment on a house). There is nothing illegal or unethical about market timing.

The mutual fund scandals from a few years back was FRAUD not market timing. Select people got to buy shares on the previous days closing price, which was unethical and illegal.

The financial industry wants to brainwash people that market timing is wrong because they want more assets to manage. The more money they manage the more profits they earn. They want you to leave your money with them forever (buy and hold).

By: Ian

Ian — Mon, 05 May 2008 20:47:02 +0000

Given the uncertanties of the stock market, if someone suggests a very specific ratio then they are probabl trying to bamboozle you. In general, it seems like you want proportions that aren’t too small, so rebalancing will have a large effect, and you probably want to concentrate a little extra in areas that tend to be better performers (stocks). Low correlation among your assets is what really matters.

By: sam

sam — Mon, 05 May 2008 20:19:44 +0000

I have yet to hear a what I consider a convincing argument for asset rebalancing in the first place. To use your example above, why is a 70/30 percent stock/bond ratio good? Where did the ratio come from? Why is a 75/25 percent ratio five years later bad? Seems to me that these ratios are just pulled out of the air. Are there any heavy duty financial calculations involved here. A risk analysis or probability analysis? Maybe it is because the ratios alway seem to be some multiple of 5 or 10 percent that bothers me. Maybe if my ideal stock/bond ratio was 68/32 I might be more impressed with the concept.