Re-balancing during accumulation stage

[pp2910]

Hello Everyone

I have just started investing in the permanent portfolio using ETFs. I was wondering if anyone has done any back-testing on when to re-balance in accumulation stage.

I am planning to invest every month. Should I allocate 25% in each month irrespective of how individual assets performed in the previous month?

Here is an example:
Invest $1000 each month ($250 per asset class)

Month 1 Beginning Balance:
IAU = SHY = VTI = TLT = 250

Month 1 returns:
IAU = 10%
SHY = 0%
VTI = -5%
TLT = 2%

Month 1 Ending Balance:
IAU = 275
SHY = 250
VTI = 237.5
TLT = 255

My question is in Month 2 should I invest 250 in each asset or should I re-balance i.e. invest 229.375 in IAU, 254.375 in SHY, 266.875 in VTI & 249.375 in TLT?
Without Re-balancing Month 2 beginning balance is:
IAU = 525
SHY = 500
VTI = 487.5
TLT = 505

With Rebalancing:
IAU = SHY = VTI = TLT = 504.375

[Lone Wolf]

Welcome!

There are several possible approaches, all fairly simple.

First, you could simply purchase whatever assets are "lagging" each month to bring yourself to 4x25%.  With this method you are indirectly considering how assets performed in the prior month, but as any kind of indicator of what will happen next month.  You are simply staying as close as possible to balanced.  This approach might have higher transaction costs than others since you will be making purchases much more frequently.

Also, you could simply accumulate into cash and then rebalance on the normal bands, such as when any asset reaches 15% or 35%.  (Alternately, many use 20% \ 30%).  If you have a cost-free way to accumulate into cash (such as the ability to purchase and sell Treasury Bills for free at Fidelity, Schwab, etc.) this winds up being a nice option as it has few transaction costs.  If your earning power is big relative to your savings, cash will crack its upper band reasonably often.

Finally, you could do something just like the above but hold "cash" to a tighter upper band (such as never allowing it to go over 28%) so that things stay closer to balance.  This means that any time cash gets above 28% you spend that 3% overage to buy the other assets.

All of them should work great so long as you try to always own all the assets and resist urges to time the market (and they will inevitably come to you as they do to all of us.)  Good luck!

[Storm]

Greetings, and welcome.  I do something similar.  I get money deposited into my 401k brokerage link account every 2 weeks with my paycheck.  What I do is just buy whatever asset is the lowest percentage wise.  So, if IAU = 26%, TLT = 25%, VTI = 24%, and cash = 25%, I'll just buy some VTI.  This has two good things going for it - you are always buying when something is lower, or has taken a loss recently, and you can avoid rebalancing more often.

The exception I make to this rule is if the buy indication is for something that would require a commission or fee.  For my 401k at Fidelity, I can buy bonds and mutual funds commission free, but if I want to buy an ETF like IAU, it costs $7.95.  For this reason, if I have a buy indication for gold, I might wait a few months until I have at least a few thousand $ to buy, so I'm not killing myself with fees.

I figure overall it's best to avoid rebalancing if you can - my PP crosses both tax free (401k/IRA) and taxable accounts, so rebalancing might occasionally cause a tax hit for me.

[Tortoise]

My rebalancing approach is basically the same as Storm's. Whenever new money gets deposited in my account, I simply buy the lagging asset. If there is a purchase fee, I wait until the deposits exceed $2,000 before I make the purchase.

[Pkg Man]

I decided to rebalance once per year, adding to cash until then.  But I can see some possible advantages of adding to the lagging assets as you go along.

[MediumTex]

One use of PRPFX is as a holding pen for future HB PP contributions.  For example, you could contribute to PRPFX until it hits $10,000, then allocate this amount to your HB PP (leaving aside tax considerations) and start over.

I don't do this, but it always struck me as something that could be viable.

[6 Iron]

I think any or all of the above strategies are unlikely to have much difference over the long haul. I have been a "lagging asset" contributor, and like it for two big reasons: the permanent portfolio is so low maintenance that it satisfies my urge to do something more frequently, and there is tremendous satisfaction in looking back and seeing the great deals you got simply by buying what is out of favor. That said, I have been adding to cash, and making purchases of the lagging asset about every three months.

[Storm]

One use of PRPFX is as a holding pen for future HB PP contributions.  For example, you could contribute to PRPFX until it hits $10,000, then allocate this amount to your HB PP (leaving aside tax considerations) and start over.

I don't do this, but it always struck me as something that could be viable.

One issue with this is that any gains in PRPFX would be short-term capital gains, and might be subject to higher tax rates when you liquidate them.  Of course if you are using a 401k this wouldn't be an issue, and seems like a good way to hold money in something besides cash.  Another issue you might have - I'm not sure if PRPFX is like this - but if you make short term (less than 1 year) holdings of some mutual funds too often, your brokerage might flag your account as high risk.  I'm not sure how this works exactly, but I remember when I first started the PP, I liquidated my JAFIX (Janus Fixed Income Fund) after only holding it for a few months, and Fidelity popped up a warning saying that something I was doing was "naughty" (selling too soon) and I shouldn't do it very often or I would be flagged as a high risk investor, or something like that.

[AgAuMoney]

Wow, I agree 100% with the alternatives proposed by Lone Wolf and Storm. 

My approach (in all my accounts not just the PP) is everything goes into cash until enough accumulates that a purchase will cost less than 2% of the new investment.  That's a hard rule.  I prefer to wait until cost will be less than 1% while watching for a short-term move that makes a buy more appealing.  When time comes to buy, the cash will be used to purchase the lagging asset(s) to bring my allocation more to target which will minimize or eliminate any need to sell asset(s).

If I do need to sell assets in order to rebalance, the entire round-trip transaction (sell and buy) must be well under 2% so that all costs included will be less than 2% of the amount.

That's the theory.  To put round numbers into it...  At scottrade it costs $7 per trade.  I might invest new cash if I have $400 or more in one trade.  If I have to rebalance (sell one then buy one) the two trades will cost $14 so my minimum rebalance amount is typically about $1000.  If I need to sell one and buy two (three trades, $21) my minimum will be more like $1500 (cost about 1.4% plus taxes).  For a sell two and buy one (also $21) I might sell as little as $700 from each (cost about 1.5%+).

If you start adding up those $400, $700, $1500 minimums, you can see it gets really hard to maintain a small (e.g. a first year IRA) account with any kind of diversification.  That's the only use I'd have for a mutual fund like PRPFX and even then I'd do something else (e.g. open the IRA in 1st quarter when I can put two years contribs in at once, and/or have only two asset classes in the IRA).

[Storm]

AgAuMoney - wow, you are right about those smaller accounts.  I have just over $4K of long bonds in an IRA, and when the coupon payment hit, I don't know what to do with the little bit of cash left in there.  I'll probably just buy a few shares of FSTMX (stock index) since there is no commission.

Pretty soon I'll probably have a little bit of everything in every account - 401k, IRA, brokerage.  It helps for rebalancing but it can get confusing sometimes... lol

[SanMiguel]

Wow, I agree 100% with the alternatives proposed by Lone Wolf and Storm. 

My approach (in all my accounts not just the PP) is everything goes into cash until enough accumulates that a purchase will cost less than 2% of the new investment.  That's a hard rule.  I prefer to wait until cost will be less than 1% while watching for a short-term move that makes a buy more appealing.  When time comes to buy, the cash will be used to purchase the lagging asset(s) to bring my allocation more to target which will minimize or eliminate any need to sell asset(s).

If I do need to sell assets in order to rebalance, the entire round-trip transaction (sell and buy) must be well under 2% so that all costs included will be less than 2% of the amount.

That's the theory.  To put round numbers into it...  At scottrade it costs $7 per trade.  I might invest new cash if I have $400 or more in one trade.  If I have to rebalance (sell one then buy one) the two trades will cost $14 so my minimum rebalance amount is typically about $1000.  If I need to sell one and buy two (three trades, $21) my minimum will be more like $1500 (cost about 1.4% plus taxes).  For a sell two and buy one (also $21) I might sell as little as $700 from each (cost about 1.5%+).

If you start adding up those $400, $700, $1500 minimums, you can see it gets really hard to maintain a small (e.g. a first year IRA) account with any kind of diversification.  That's the only use I'd have for a mutual fund like PRPFX and even then I'd do something else (e.g. open the IRA in 1st quarter when I can put two years contribs in at once, and/or have only two asset classes in the IRA).

2% is quite high when the PP makes 8% per year?
So, you only buy 1 asset at a time rather than a full rebalance?

[cowboyhat]

Buying every month would mean looking at my investments too often. My peace of mind is improved by ignoring my investments and markets as much as possible. That is one of the wonderful things about the PP.

Another thing is that if you back test the PP, returns are better with less frequent rebalancing. Repeatedly rebalancing into declining assets hurts performance.

My approach is to look once a year and rebalance if something is at 15% or 35%.

[SanMiguel]

Buying every month would mean looking at my investments too often. My peace of mind is improved by ignoring my investments and markets as much as possible. That is one of the wonderful things about the PP.

Another thing is that if you back test the PP, returns are better with less frequent rebalancing. Repeatedly rebalancing into declining assets hurts performance.

My approach is to look once a year and rebalance if something is at 15% or 35%.

One issue here is that backtesting doesn't take into account commissions?
If you knock off that 1-2% you are paying in commissions each time you rebalance then the compound effect over the lifetime of the portfolio must be quite significant.

[AdamA]

One issue here is that backtesting doesn't take into account commissions?
If you knock off that 1-2% you are paying in commissions each time you rebalance then the compound effect over the lifetime of the portfolio must be quite significant.

Commissions are definitely a pain, but should be no where near 1-2%.  In some cases (stock index fund transactions with a broker like Vanguard or Fidelity), they will be 0.

[SanMiguel]

One issue here is that backtesting doesn't take into account commissions?
If you knock off that 1-2% you are paying in commissions each time you rebalance then the compound effect over the lifetime of the portfolio must be quite significant.

Commissions are definitely a pain, but should be no where near 1-2%.  In some cases (stock index fund transactions with a broker like Vanguard or Fidelity), they will be 0.

Yeah, but a fund charges you within the fund...hidden.
ir if index went up 25%, you will only see something like 23-24% of that, so whether I pay a commission or buy a fund that charges the equivalent of the commission doesn't seem to make a lot of difference. I agree vanguard are cheaper than most but anything that is listed as an ETF attracts a commission charge to buy here in the UK. Anything that is a fund has at least a 1.5% TER, not seen many cheaper.
You can't avoid that but it is necessary to keep the overall expenses to less than 1% pa.

[AdamA]

[quote author=SanMiguel link=topic=998.msg11205#msg11205
Yeah, but a fund charges you within the fund...hidden.
ir if index went up 25%, you will only see something like 23-24% of that.
[/quote]

That's not a commission, that's the expense ratio, and it only applies to ETF's or mutual funds.

Physical gold--no expense ratio.
T-bonds--no expense ratio
T-bills--no expense ratio
S&P index--should be no more than .5%

[SanMiguel]

[quote author=SanMiguel link=topic=998.msg11205#msg11205
Yeah, but a fund charges you within the fund...hidden.
ir if index went up 25%, you will only see something like 23-24% of that.

That's not a commission, that's the expense ratio, and it only applies to ETF's or mutual funds.

Physical gold--no expense ratio. What about the market spread over the spot price?
T-bonds--no expense ratio. Attracts a commission to buy within a pension in UK.
T-bills--no expense ratio. Attracts a commission to buy within a pension in UK.
S&P index--should be no more than .5%. - an index fund with a 0.5% TER? really? Does Vanguard have 1 for the FTSE? I still think it attracts a £10  commission in the UK.


[/quote]

[AdamA]

That's not a commission, that's the expense ratio, and it only applies to ETF's or mutual funds.

Physical gold--no expense ratio. What about the market spread over the spot price?
T-bonds--no expense ratio. Attracts a commission to buy within a pension in UK.
T-bills--no expense ratio. Attracts a commission to buy within a pension in UK.
S&P index--should be no more than .5%. - an index fund with a 0.5% TER? really? Does Vanguard have 1 for the FTSE? I still think it attracts a £10  commission in the UK.

You are mixing and matching commissions and expense fees.  

Commissions are paid to your broker each time you make a purchase or a sale.

Expense fees are taken by the custodian of a mutual fund or ETF, usually as an annual percentage of the total amount held in the fund.

You will probably rebalance your PP once every 4-5 years.  Commissions from this should run no more than $100.

The expense ratio for VFINX (Vanguard's S&P 500 index mutual fund) is .17%.  No commission to buy and sell within a vanguard fund.  

T-bonds  Usually carry a $40-$50 commission if you buy/sell them on the secondary market.  At primary auction, there is no fee, and there is definitely no expense ratio.  

T-bills  No commission or fee if bought from treasury

Gold does have a bid ask spread, plus a commission.

Summary:

S&P Index:  .17% per year
Tbonds:  $50 per transaction
T-bills:  $0 per year
Gold:  bid/ask spread + commission

No way this should go over .5% a year, unless you are really transacting piecemeal, in which case I would suggest saving a bunch of cash, and then buying assets yearly.  

[Lone Wolf]

T-bonds  Usually carry a $40-$50 commission if you buy/sell them on the secondary market.  At primary auction, there is no fee, and there is definitely no expense ratio. 

You can also grab Treasury Bonds with no fees at Fidelity and Schwab on the secondary market.  The spreads are miniscule as well so it's a nice way to go.

For the S&P Index, VTI and SCHB both carry 0.06% ER's, so those are great options when looking at ETFs for the US stock market.  Roll that in with T-bills, T-bonds and physical gold and you arrive at MediumTex's super-low 0.015% expense ratio Permanent Portfolio.  It's a beautiful thing.

San Miguel, perhaps this guide to cheap UK index funds would be useful to you?  I saw some ER's at less than .3%, which is at least "okay".  Do your own due diligence of course, as I know virtually nothing about the UK markets. 

[Tortoise]

For the S&P Index, VTI and SCHB both carry 0.06% ER's, so those are great options when looking at ETFs for the US stock market.  Roll that in with T-bills, T-bonds and physical gold and you arrive at MediumTex's super-low 0.015% expense ratio Permanent Portfolio.  It's a beautiful thing.

That super-low expense ratio might seem even more impressive when expressed in dollar terms: only $150/year to maintain a $1 million PP.

I spend more than that on coffee each year.