By JLP | October 20, 2010
This is a continuation of yesterday’s post.
I ran the numbers under the following two scenarios:
• $500 per month with no rebalancing.
• $500 per month with annual rebalancing.
Here are what the numbers look like:
I have to say that this one surprised me until I considered everything that has happened over the last 19 years. So much of portfolio returns are due to timing. The equity portion of the portfolio grew nicely throughout the 90s but cratered with the bursting of the internet/tech bubble in the early 2000s and then again in 2007 and 2008.
So there you have it. Bonds beat stocks in this scenario so bonds are better, right? Not so fast. Take a look at the next graphic, which is like the first graphic only this time, the portfolio is rebalanced back to the original allocation at the end of each year.
Rebalancing was the difference maker. The sweet spot seems to be around a 50/50 split between stocks and bonds. Rebalancing is important because it adds a sense of discipline to the portfolio in that investors are selling appreciated assets and buying more of assets that have decreased in value. This was particularly important over the last 19 years due to the way the stock market behaved.
It’s important to note that we shouldn’t focus too much attention on a two asset portfolio. This was more of an exercise in seeing how stocks and bonds work together.
What does the future hold? Well, that’s anybody’s guess. If we have inflation (as many economists are expecting), U.S. bonds will not do well. If we don’t get our economy back under control, stocks won’t perform well either.
That’s why at this point in the game, I’m thinking a prudent portfolio is something like Craig Israelsen’s 7Twelve portfolio, which invests in 7 different asset classes via 12 different funds/ETFs. For those who are interested, I interviewed Dr. Israelsen recently.