By Brett Arends
How often should you look at your portfolio?
The swings in the market since the start of the year have raised again the issue of whether it’s foolish to pay too little attention to what’s going on with your money... or too much.
It’s easy to get spooked by the news and sell just before things rally again. Or to want to jump onto a bandwagon—just before the wheels come off.
Some people argue you should pay almost no attention whatsoever. They think the market is so rational, perfect and efficient than any attempt to beat it, or second-guess it, or outsmart it, is doomed to fail.
At most, they say, you should check in once a year—and at that point you should do no more than “rebalance” your portfolio to your target asset allocation, selling a little of whatever has done best over the preceding 12 months and buying a little of whatever has done worst in order to restore the proportions. (They often suggest doing this on your birthday, on the reasonable grounds that this minimizes the risk you will forget)
Is that often enough?
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If you subscribe to the idea of running a “passive” portfolio based on target asset allocations, there are two reasons to rebalance (although the main advocates usually only admit to one). The first is to make sure your portfolio remains as you intended. If you didn’t rebalance, then you might end up with too many stocks, or bonds, or soybean futures, or gold, depending on which had risen the most. The second reason is that it offers a certain amount of market contrarianism. The rebalancer, by definition, is betting against the trend in the market by selling a little of what has done best lately in order to buy a little of what has done worst.
Someone who rebalanced was selling technology stocks in late 1999 and early 2000 and buying good old-fashioned “value” stocks. They were buying emerging markets during the Asian Tiger crash of 1997-8 and the post-9/11 panic of 2001-2. They were cashing out of bubble markets in 2006-7 and buying Treasury bonds. And so on.
Often, the people who champion rebalancing denigrate any of this kind of “market timing” or market second-guessing. But it’s an integral part of the strategy.
The best thing about periodic rebalancing is that it removes all emotion from the process. You never find yourself “holding off” from buying a tumbling asset “until it bottoms,” or trying to ride a bubble to the top.
So how often should you do it?
I decided to run two experiments to have a look.
Both experiments involved four notional people: Mr. Lazy, who never rebalances, Ms. Birthday, who rebalances once a year, Mr. Quarter, who rebalances every three months, and Miss Monthly, who, as her name suggests, rebalances every month.
I then looked at how each of them would have fared in recent decades using two different sample portfolios.
The first portfolio was spread equally across five asset classes: U.S. stocks, stocks of developed economies overseas such as Europe and Japan, emerging market stocks, inflation-protected U.S. Treasury bonds, and long-term regular U.S. Treasury bonds. Someone holding this portfolio has a balance of 60% stocks and 40% bonds; the stocks are highly diversified across three major global groupings; and the bonds are split between those which are protected against inflation and the long-term bonds which are most valuable in a market panic or sell-off, when they (unlike everything else) tend to go up.
To run the experiment I used the portfolio service offered by Lipper, Inc., a fund-analysis service owned by Thomson Reuters. For the sake of illustration I built the portfolio using five Vanguard funds: Vanguard Total Stock Market Index /zigman2/quotes/202876707/realtime VTSMX -4.65% , Vanguard Developed Market Index , Vanguard Emerging Market Stock Index /zigman2/quotes/205715973/realtime VEIEX -2.41% , Vanguard Inflation-Protected Securities /zigman2/quotes/207983017/realtime VIPSX +0.37% and Vanguard Long-Term Treasury /zigman2/quotes/201786083/realtime VUSTX +1.47% .
I started the experiment in June 2000, the earliest date from which all five funds were available, and continued to the present.
Bottom line? Mr. Lazy did worst. Mr. Quarter did best. Miss Monthly could have saved herself a lot of bother. Not only did she do worse than Mr. Quarter, but she even did worse than Ms. Birthday.
Each of the four started out with $100,000 invested in their portfolios — $20,000 in each of the five funds. Today Mr. Lazy, returning from his fourteen-year sojourn on Aruba and checking into his account for the first time in 14 years, is pleased to see his wealth has grown to $209,000. During that time we have seen the collapse of the stock-market bubble and the dot-coms, 9/11, the Enron and WorldCom scandals, the Iraq war, the housing bubble, the Lehman Brothers collapse, the worst housing and financial crises since the Depression, the implosion of Greece, Dubai, Iceland and so on, and various other manias, madnesses and panics. And in all that time Mr. Lazy has paid no attention to it all. And throughout that time his wealth has grown by 5.5% a year.
Miss Monthly, on the other hand, has been a busy bee. She has checked in to her account every month and made the necessary changes. She hasn’t tried to be too clever. She hasn’t tried to second guess the market or change her fundamental allocation. But she’s made sure to rebalance her portfolio back to its original allocations 12 times every year.
What is her reward for this? Today she has $221,000 — or $12,000 more than Mr. Lazy.
Or, to put that in context, she earned a grand total of $70 for each of the 168 times she logged on to her account and made the necessary trades.
That, of course, is before any taxes or other transaction costs.
Well, it’s something. But it is hardly a king’s ransom.
Ms. Birthday, meanwhile, ended up with $223,000. In other words she earned $3,000 more than Miss Monthly, even though she traded one twelfth as often.
She traded 14 times more often than Mr. Lazy, and ended up with $14,000 more. In other words, she earned $1,000 for each time she logged in to her account and made changes (before costs, of course).
The best of all, however, was Mr. Quarter. He ended up with nearly $227,000. In other words he made $18,000 more than Mr. Lazy in the course of 14 years. His annual return on investment topped 6%: Not bad, given that he did nothing more than log in to his account once every three months.
For a second experiment, I looked at how the same four investors would have fared over a longer period of time. Once again using Lipper, I imagined that each of the four started with $100,000 20 years ago, in 1994. And I imagined that in each case they built a portfolio spread equally between three assets: U.S. stocks, emerging market stocks, and the bond market. (I used the Vanguard Total Stock, Emerging Market Stock, and Bond Market Index funds, three funds which existed throughout that period and for which data are available).
Bottom line? The results were pretty much in line with the first experiment. Mr. Quarter did best. Mr. Lazy did worst, although once again not quite as badly as you might have expected. Miss Monthly could have saved herself her time and energy. She did worse than Ms. Birthday.
Going back over 20 years, we really are delving into ancient history. In 1994, Barings had yet to go bankrupt. The Internet was in its early stages. Google hadn’t even been invented, and Amazon was in its infancy. Your correspondent was considered on the cutting edge because he read news online, on a black screen, using a 14.4k dial up modem. The Asian Tigers were only just getting going on their massive bubble of the mid-1990s.
How did these portfolios fare?
Mr. Lazy saw his $100,000 investment swell to $405,000 — a remarkable sum for no work.
Miss Monthly ended up with $441,000. Ms. Birthday ended with $445,000. But Mr. Quarter trumped them all, finishing with $459,000. That’s $54,000 more than his super-lazy counterpart.
Mr. Lazy earned 7.2% a year with no effort at all. Mr. Quarter earned just under 8%.
I should add that the drawdowns—the sharpest falls from peak to trough—were comparable across all four portfolios.
The results are reasonably intuitive. They support the suspicion that paying too much attention to the market, by rebalancing every month, is almost as bad as paying too little. But they do suggest that a certain amount of activity pays rewards.
They also show that nothing is your friend so much as time.
I ignored taxes and transaction costs. They are unknowable from person to person. And many people hold the bulk of their investments in tax-deferred accounts, such as 401(k)s and IRAs. But obviously if you must pay tax on every realized gain, and transaction costs on each transaction, then that is an argument for rebalancing less often.
There is one other argument for rebalancing less often. Brendan O’Brien, of Gold Coast Wealth Management in New York, notes that human nature is such that we feel a loss much more keenly than we feel a gain. Research suggests that the loss of a dollar weighs about twice as heavily on us as the gain of a dollar cheers us up. Given that markets go up and down, O’Brien notes, this simple psychological insight means that checking into our accounts more often raises the risk of simple unhappiness. We’ll only be slightly cheerful if we check in and see that our investments are up. But we’ll be really miserable if we check in and see that they are down.
And then we might be panicked or alarmed into making a foolish move and changing our allocation needlessly, he adds.
Factor this in, and Miss Monthly really does do worst of all.
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