Allan Roth is the founder of U.S.-based Wealth Logic LLC and his recent column on the positive effects of forced portfolio rebalancing is a great example of what Warren Buffett meant when he described his investment style as 'simple but not easy'.
Mr. Roth found that with a simple portfolio consisting of a U.S. equity index fund, and bond ETF, and an international stock ETF, portfolio performance was significantly improved by rebalancing twice per year to a target asset allocation. The performance benefits occurred in each of aggressive, moderate and conservative allocations.
The 'simple' part of Mr. Roth's advice is obvious. In the case of the moderate risk allocation, the portfolio was rebalanced to 40 per cent U.S. equities, 20 per cent international stocks, and 40 per cent bonds on June 30 and December 31 each year.
The approach offers the advantages of enforced discipline. The paring back of the most successful portion of the portfolio every six months helps limit losses when that sector gets hit with the inevitable sell-off. Buying more of the worst-performing asset class makes it more likely to find profitable entry points.
It's easy to see how an investor might be tempted to ignore rebalancing at certain times. A strong period for international equity returns and a positive outlook would make anyone reluctant to sell part of the position. Avoiding the temptation to break the rules is the psychological 'not easy' part.
Most Canadians are aware of the long term benefits of passive, index-based investing. Knowing this, however, is not much help in determining how much wealth to allocate to Canadian and foreign equities, and fixed income.
The correct allocation will vary from person to person – age is an important determinant of fixed income holdings, for instance, and investors have individual risk tolerances. But the process of forced rebalancing will help maximize the benefits of asset allocation no matter which strategy is most appropriate.
-- Scott Barlow, Globe and Mail market strategist
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