PP expected return

[KevinW]

You also need to factor in the rebalancing bonus. Some of the returns come from the buy low/sell high behavior of the rebalancing bands. IIRC this provides something like an extra +2% return versus the average expected values of the four components.

I would put tax-sheltered cash at 0% real; and gold at -0.5% net after holding costs. Based on historical averages I would use higher numbers for bonds and especially stocks.

[buddtholomew]

There are countless debates on whether a re-balancing bonus exists. We re-balance our holdings to restore the risk profile of the portfolio and not to increase returns. If anything, re-balancing should result in lower portfolio returns as the appreciating asset could be trimmed well in advance of reaching its potential.

[KevinW]

Is the goal of this thread to come up with numbers that feel right, or come up with numbers based on empirical evidence?

Have you guys read the modern portfolio theory literature that supports the existence of the rebalancing bonus?

[MeDebtFree]

Trying to quantify PP expected return is difficult.  IMHO, future returns for quite some time will be lower than their historical-to-date CAGR.  A few years ago I did some simple analysis looking at sliding windows of trailing 3, 5, and 10 year returns and the trends/regression lines were all clearly negative sloping.  And, that was when cash was returning something and while long term rates were falling for many, many years.  Now, cash returns nothing and long term rates are unlikely to fall, more probably stay flat and sooner or later rise.  And, if I remember right, the "early years" (i.e., the 70s and early 80s) really stood out visually as the peak years for the PP compared to the remaining time frame.

I keep the following in mind, though.  One thing that is not emphasized very much in these discussion forums is that when reading HB's book(s) and listening to his radio shows, his primary statement about the PP goes something like "The Permanent Portfolio is for your money that you cannot afford to lose".  Not losing money vs. getting a respectable return are 2 different things.  I would say 95+% of discussions about the PP is related to returns rather than focusing on protecting against loss.  In that respect, the PP has done and (my guess is) will continue to do that pretty well (i.e., you won't lose much, if anything).  But, I am also guessing that a 8-9% CAGR is unlikely for the foreseeable future (I am planning my finances around the lower end of a guess of 5-7%).

I still have much of my net worth in a PP and that works for me because I am not interested in volatility at this point in my life.  I have young adult children who are just getting started and I am advising them to live with the volatility and invest entirely in growth stocks for the next decade, maybe two, until they get a good size nest egg.  At that point, they can evaluate a PP style investment and determine for themselves if the PP tenets still make sense.

Anyway, my two cents (and there are those that will tell you that is about what my advice/insights are worth  ).

[MeDebtFree]

There is no consensus regarding a rebalancing bonus.  It's a lot more complex than it sounds at first glance.  It depends on momentum versus reversion-to-the-mean (RTM), return differences between asset classes, correlations, rebalancing frequency, and luck.  The "bonus" can be positive or negative, depending on timing and behavior of the asset classes.  In the case of gold, I think there's a good argument to be made for a positive rebalancing bonus, since its correlation with LT and equity is low, and it tends to mean-revert over LONG periods of time. 

So, what number would you plug in for a rebalancing bonus?

Based on the historical data I have, my computations say the rebalancing bonus is 1.1% (total return).  I have no better guess than that and have no faith that number is even remotely meaningful going forward.

[Kshartle]

It's definitely not meaningful going forward. There is no rebalancing bonus. I know we've gone over this in a bunch of threads and conclusively proven it. Any argument for rebalancing increasing returns is the identical argument for it hurting returns. Believing that following a rebalancing rule will result in higher returns is believing in a free lunch that doesn't exist.

For any given set of years there is an optimal rebalancing or non-rebalancing that would have resulted in the highest returns but you have no way of knowing what that is beforehand.

So many people here hold this misconception that maybe the hosts could put it in the FAQ.

There is a logical reason why in the very long run it's probably almost certain that rebalancing hampers returns. Due to the nature of the asset classes, over very long periods the stock market should be far and away the best performer. Income generating businesses and the risk premium for owning such an asset should prove to be more profitable over time than government bonds or a lump of gold. Of course there is no way of knowing how long it will take for stocks to get an insurmountable lead over the others so I am referring to the very long term. This makes logical sense though and I'm sure the historical numbers bear this out.

Therefore, you probably stand the chance of getting the greatest returns by NEVER rebalancing because you would never be selling the longest term winner.

Of course now you might have more volatility than you can bear but if you are accumulating who really cares? I'm accumulating so I just buy stocks or gold every month, whichever is lower and never sell. It's not as volatile as you might think since they are non-correlated but I've been buying my gold in the ground (gold stocks) so it's hurt pretty bad.

[Tlagnhoj]

the rebalancing bonus is a result of cognitive biases which affect most investors. things such as panic selling (flight response) and thoughtlessly/greedily buying (herd mentality), among others.

investors that employ a reasonable systematic rebalancing method, and do so with discipline, tend to collect some of the amount by which the average investor underperforms the index due to acting with cognitive bias. since this underperformance tends to be quite substantial, we can then also infer that the rebalancing bonus to be collected is likely non-trivial.

to expect something in the realm of 100-300 bps seems possible and reasonable.

when most investors stop acting with significant cognitive bias/emotion, in their  financial decision making, then this bonus amount should be substantially reduced or even eliminated. don't hold your breath waiting for that to occur.

[kka]

It's definitely not meaningful going forward. There is no rebalancing bonus. I know we've gone over this in a bunch of threads and conclusively proven it. Any argument for rebalancing increasing returns is the identical argument for it hurting returns. Believing that following a rebalancing rule will result in higher returns is believing in a free lunch that doesn't exist.

Wrong.  There's been ~1% CAGR rebalancing bonus over 40 years (as well as much smaller draw-downs), and there good reasons to expect that to continue.

http://www.efficientfrontier.com/ef/996/rebal.htm

http://www.stableinvesting.com/2013/04/ ... demon.html

[Kshartle]

It's definitely not meaningful going forward. There is no rebalancing bonus. I know we've gone over this in a bunch of threads and conclusively proven it. Any argument for rebalancing increasing returns is the identical argument for it hurting returns. Believing that following a rebalancing rule will result in higher returns is believing in a free lunch that doesn't exist.

Wrong.  There's been ~1% CAGR rebalancing bonus over 40 years (as well as much smaller draw-downs), and there good reasons to expect that to continue.

http://www.efficientfrontier.com/ef/996/rebal.htm

http://www.stableinvesting.com/2013/04/ ... demon.html

Wrong. As proof I can cite numerous time periods 30+ years in length. If there was such a thing you would be able to point to a certain time-period where this would be certain because it would actually be based on something real, not imagined.

You can data-mine any set of returns for an optimal strategy to follow but there is no predictive value from the data-mining. If rebalancing annually is better than every five years, then why is twice a year not better? If it's based on % instead, why is 35/15 better than 36/14 or 34/16 or 50/10?

Any "bonus" is just looking back at what happened.

As proof I will cite random internet article A and random article B.

[Kshartle]

Here kka:

http://www.peaktotrough.com/hbpp.cgi


Use that to test the theory.

If you run from Jan 1 1981 through today the CAGR for no rebalance but reinvested div and interest (which is truly letting the investmests ride)....is 8.16%. With 35/15 it's under 8%.

That's 33 years with re-balancing resulting in lower returns. My point is it's all just data mining. Additionaly this is starting with interest rates very high boosting bond returns over the decades. I suspect this will become more skewed unless we get a real stock market collapse.

If there was no rebalance bonus over 33 years, do you really think one exists? If it does....how many more years do we have to wait to be sure we'll see it?

[KevinW]

I think the premise of this thread is to look at long time periods, in other words the limit as the time horizon approaches infinity. That's the only context where it can make sense to say, for example, that gold has 0% returns. Gold is certainly very volatile over horizons of days or a few years. But in the very long term (centuries?) it should, in principle gold should return 0% before expenses since the properties that make it valuable never change and it does not earn interest or appreciate.

The rebalancing bonus is positive because compound interest follows an exponential function. Exponential functions are convex. For any convex function f(x) and a <= b, the average of the endpoints (f(a) + f(b)) / 2 is greater than or equal to the function value at the midpoint f((a+b)/2) (the definition of convexity). So when you compare holding an interest-earning asset over an interval, to rebalancing in and out of it partway through the interval, the rebalancing approach comes out ahead.

PS, you can't prove by example, that's now how logic works.

So, what number would you plug in for a rebalancing bonus? 

This was discussed at length here a while ago, and unfortunately I don't remember what the consensus was or where the link is.  IIRC it was in the 1-2% range.

Wrong.  There's been ~1% CAGR rebalancing bonus over 40 years (as well as much smaller draw-downs), and there good reasons to expect that to continue.

http://www.efficientfrontier.com/ef/996/rebal.htm

http://www.stableinvesting.com/2013/04/ ... demon.html

Thanks for posting these.

[Kshartle]

PS, you can't prove by example, that's now how logic works.

Yeah but you can disprove with examples.

There is no logic to support the concept. Did you read the articles?

If there is a rebalancing bonus...why has it not worked for 33 years? How many more years do we have to wait for it? You must believe the rebalancing bonus only exists after 33 years because I've just proven it doesn't exist under that, unless I bungled the tool. Perhaps someone else can double-check my work...I did it quickly.

[KevinW]

Which articles? The ones kka posted argue cogently that a rebalancing bonus exists.

If there is a rebalancing bonus...why has it not worked for 33 years? How many more years do we have to wait for it? You must believe the rebalancing bonus only exists after 33 years because I've just proven it doesn't exist under that, unless I bungled the tool. Perhaps someone else can double-check my work...I did it quickly.

Did you read the part of my post where I said these principles play out over very long time scales?

[Xan]

I would think 32 years is long enough to be considered nonexistent for many investors.

[Kshartle]

Which articles? The ones kka posted argue cogently that a rebalancing bonus exists.

If there is a rebalancing bonus...why has it not worked for 33 years? How many more years do we have to wait for it? You must believe the rebalancing bonus only exists after 33 years because I've just proven it doesn't exist under that, unless I bungled the tool. Perhaps someone else can double-check my work...I did it quickly.

Did you read the part of my post where I said these principles play out over very long time scales?

I did read them. The first one argues that there will be an optimal rebalancing number for a given portfolio over a given timeframe (duh). He argues that it is possible to "predict" whether it's better to rebalance monthly, quarterly or annually after you get the return, std dev and correlation of asset pairs and then go back and do re-balance testing. I don't see where there is any predictive value here....just data-mining. His work was all done by looking over a 6-year period. It's like he's suggesting based on some inputs you can look back and guess at what would have worked best. Well ok thanks for nothing.

Maybe there is something more there that I didn't see or understand.

He also points out that:

"The return on common stock for the period 1926-94 was 10.19%, and for long term corporate bonds over the same period 5.51%"

"Rebalancing this portfolio on an annual basis to maintain a 50/50 mixture yields a return of 8.34%"

"In fact, however, if one had put equal amounts of money into stocks and bonds on January 1, 1926, and had not rebalanced or paid taxes, then the long term return would have been 9.17%. In this instance the nonrebalanced portfolio has a higher return than the rebalanced portfolio. This is because over the 69 year period studied the significantly higher stock return overwhelms the bond return; for the last 40 years of the period the unrebalanced portfolio consists of greater than 90% stock. Thus the higher return of the unrebalanced portfolio comes at the cost of a much higher risk than the rebalanced one.

So after 69 years non-rebalancing provided higher returns.

Perold and Sharpe2 point out that rebalancing is a "concave" strategy. Portfolio insurance represents the opposite of rebalancing, and is referred to as a "convex" strategy. They suggest that convex portfolio insurance strategies as well as buy and hold ("flat") strategies produce superior returns in markets with a prolonged upward (or downward) bias, and concave rebalancing strategies produce superior returns in stagnant markets."

We've gone over this plenty of times and I'm sure I pointed this out in much easier language. Maybe I can find the thread. Re-balancing will return higher when trends are shorter and not as significant. The problem is you don't know when one is starting and how long it will last and how far it will go.

The rebalancing strategy is only useful for volatility/risk reduction. You can't expect it will return anymore than a non-rebalanced portfolio and I think the data and logic all suggest the longer the timeframe the more likely non-rebalancing will be superior due to super bull-trends.

[KevinW]

The rebalancing strategy is only useful for volatility/risk reduction. You can't expect it will return anymore than a non-rebalanced portfolio and I think the data and logic all suggest the longer the timeframe the more likely non-rebalancing will be superior due to super bull-trends.

What about the mathematics of compound interest and convex functions?

[Kshartle]

I would think 32 years is long enough to be considered nonexistent for many investors.

Yeah it's actually been longer than 33 years for the HBPP that non-rebalancing has been better (return-wise) and the first article points out not rebalancing a stock/bond portfolio provided higher returns over an annual reblance over 69 years. It all makes perfect sense based on the arguments I've put forth in previous threads.

As for the 2nd article.....anyone is free to explore the faulty logic or testing I'm just not interested. He doesn't even state a theory as to why rebalancing would improve returns (again as far as I could tell in a quick read). If anyone wants to explore it and explain his theory I'd be grateful.

Guys I would love a free lunch. I would love a secret re-balancing mechanical formula that automatically boosted returns. Sadly it doesn't exist or every money manager would know and be using it. It is for volatility dampning and beneficial in other ways however.

[Kshartle]

The rebalancing strategy is only useful for volatility/risk reduction. You can't expect it will return anymore than a non-rebalanced portfolio and I think the data and logic all suggest the longer the timeframe the more likely non-rebalancing will be superior due to super bull-trends.

What about the mathematics of compound interest and convex functions?

What about them? That question is too broad for me, I might end up going in a useless direction.

[KevinW]

They are the mathematical basis for why rebalancing in and out of assets gives a higher total return than holding separate assets.

[Kshartle]

They are the mathematical basis for why rebalancing in and out of assets gives a higher total return than holding separate assets.

Why do you think it hasn't worked for over 33 years? How many more years until it works for the HBPP?

Why didn't it work for the 69 years in the example given in the article? I would bet if you carry it through the present it would now be 88 years (the article was written in '96).

[KevinW]

We're talking past each other. Color me unconvinced, but I don't have the time or energy to continue this discussion.

[Kshartle]

We're talking past each other. Color me unconvinced, but I don't have the time or energy to continue this discussion.

That's fine. I thought you might want to offer a reason why you think the rebalancing "bonus" hasn't appeared even though you have faith it exists. I wasn't trying to convince you, I thought you were convinced and could maybe explain the basis.

Does anyone else want to guess how much longer until it appears? Incidently, it has to appear and stick around. If it works after 34 years but then fails again after 35 it hasn't actually worked, that's just data-mining for optimization.

[Pointedstick]

In an ironic twist of fate, we find Kshartle arguing that the observed reality doesn't match someone's theory.

[Kshartle]

In an ironic twist of fate, we find Kshartle arguing that the observed reality doesn't match someone's theory.

The argument based on logic and reason was an utter failure, as usual. 

There is a different element here however. I'm not using evidence to prove a theory, but to dissprove it. If the theory is that re-balancing provides a bonus to returns and we can see based on evidence that it clearly does not.....this how you use evidence, to dissprove, not to prove.

[Kshartle]

the rebalancing bonus is a result of cognitive biases which affect most investors. things such as panic selling (flight response) and thoughtlessly/greedily buying (herd mentality), among others.

investors that employ a reasonable systematic rebalancing method, and do so with discipline, tend to collect some of the amount by which the average investor underperforms the index due to acting with cognitive bias. since this underperformance tends to be quite substantial, we can then also infer that the rebalancing bonus to be collected is likely non-trivial.

to expect something in the realm of 100-300 bps seems possible and reasonable.

when most investors stop acting with significant cognitive bias/emotion, in their  financial decision making, then this bonus amount should be substantially reduced or even eliminated. don't hold your breath waiting for that to occur.

I just read your post Tlagnhoj. I completely agree. This is what I meant when I said "other benefits". Essentially mechanical rebalancing will save investors from themselves since the intuitive thing to do in investing generally turns out to be wrong. I'm all for re-balancing, particularly past the accumulation phase but let's not kid ourselves about some automatic 1% additional return based strictly on the mechanics.