Even Dogs Diversify

A guy we know received this birthday card from his financial adviser.

Is Portfolio Rebalancing a Waste of Time?

Could investment advisers become even more redundant? On average, they can't pick stocks that do better than average. So they settle for allocating assets and periodically rebalancing to maintain the ideal allocation. But what if their clients would be just as well off if their portfolios remained untouched?

Source: The Wall Street Journal

Some investment professionals, the WSJ reports, now believe "rebalancing is no better or worse a strategy than buy-and-hold."

A study mentioned here confirms that belief:

Compare the path of two hypothetical portfolios constructed by T. Rowe Price. Each portfolio starts with $100,000, with 60% in a mix of stocks—including shares of large and small companies, U.S. and foreign firms—and 40% in high-quality U.S. bonds. One portfolio is rebalanced annually over the 20-year period through 2015; the other is left alone. Both portfolios deliver the same returns, with annualized gains of just a bit more than 7%.

Rebalancing did reduce volatility. In theory, lowering volatility by periodic rebalancing should enable a skittish investor to come closer to  the long-term returns enjoyed by a buy-and-hold investor. 

In practice, rebalancing requires the skittish investor to shift money from stocks just when their gains make them look like a great buy and purchase stocks when their prices are scarily depressed. Easier said than done.

Asset Allocation Takes a One-Two Punch

When professional stock-picking lost credibility, wealth managers turned to asset allocation – the process of dividing client assets between equities and fixed income in proportions appropriate to age and circumstances. (Getting older? Lighten up on stocks.) Target-date funds give investors glide-path investment programs that jettison stocks as they age.

Could it all be a waste of time and money?

David A. Levine, a former chief economist at Sanford C. Bernstein & Company, believes asset allocation is wrong-headed.  In a pair of New York Times columns he delivers the old one two.

ONE
Target-date funds are misguided. Investors should not move out of equities so drastically as they retire. They shouldn't move out at all. Even in retirement, their investment horizons are like the ever-receding horizon confronting a mariner at sea. If you are 99 and investing what soon may be your family's inheritance, you still should be thinking long term.

TWO
The ideal asset allocation for the long-term investor is 100 percent equities. "Both the historical record and logic argue very strongly for stocks over bonds. Yes, stocks are more volatile, but if you recognize that the “investment horizon” is always long and always receding into the future, your best bet is to put virtually all of your liquid assets into the stock market."

Levine makes a point courageous investors might ponder, This doesn't mean advisers should worry about asset allocation going out of style. Marketing of the concept has been so successful that many investors believe asset allocation is designed to increase returns rather than reduce volatility.

Brooke Astor's Bold Investments

Tony Marshall, Brooke Astor's son, claimed to have done well investing her portfolio, turning $19 million into $80 million or more.

Sure enough, an inventory of Mrs. Astor's estate last fall, reported in The New York Times, shows investable assets totalling $79.5 million.

Her asset allocation looks much more aggressive than that of the average multi-millionaire, not to mention the average 105-year-old.

Hedge funds and private equity 59%

Stocks 30%

Bonds 10%

Cash and equivalents 1%

For comparison, Northern Trust's 2007 Wealth Survey found the average asset allocation for those with $10 million or more was 40% stocks, 15% cash, 11% bonds, 11% private equity and 2% hedge funds, plus allocations to real estate and commodities.

Hedge funds, however, are a structure for pooled investing, not an asset class. The Times reports that Mrs. Astor had $20.6 million in a hedge fund that invests in equities. That suggests that over 50% of her investable wealth actually was allocated to stocks.