Rebalancing Bands: Traditional 35/15 or a Modified 30/20?

[TripleB]

Harry Browne recommended a rebalancing band of 35/15. This represents a +/-40% deviation from the 25% base level. I calculate 40% by taking the 10% shift (either positive to get from 25% to 35%, or negative down to 15%) and dividing that by the 25% target. i.e. 10/25=0.40

Thus, an asset must move 40% in either direction, relative to another asset in the portfolio, to trigger a rebalancing act. I believe Harry Browne set these bands for several reasons:

1) Reduce the cost of rebalancing. Back in Harry's day, it cost much more money to trade stocks than it costs today. The transaction fees were higher, thus making it less worthwhile to rebalance more frequently.

2) Reduce the cost of taxes. When you sell an asset at a gain, to buy another at a loss, you trigger a taxable event.

3) Simplicity. If you select 35/15 bands, then historically you would only have to rebalance once every 2 years or so.

For my situation, I am considering a 30/20 band. Here's why:

a) My transaction fees are much lower than Harry's might have been. I can sell my Gold ETFs and buy transaction free VG Stock ETFs for virtually nothing. I believe 10+ years ago, the cost to trade stocks was based on a percentage of the overall trade.

b) My PP is entirely held within tax-sheltered accounts. I can sell Gold ETF and buy Stock ETF without triggering a taxable event.

c) I check my PP more frequently than I need to anyway. Thus changing the rebalancing band doesnt add too much undo stress on my life.

Finally, I am considering adding a second rebalancing measure. This being, "If the PP rises 10% in total since the last rebalancing time, excluding the addition of new funds, then trigger rebalancing." I may set that at 15% or 20% rather than 10%.

Theoretically the PP should rise about 10% per year, and on the best years, maybe 20% historically. Thus, even a 10% rise-band wouldn't be too ridiculous to rebalance at. My point of this band being that if the PP rises 10% it's likely due to some deviation within the internal assets. It's unlikely all 4 asset classes would rise 10% at the same time. It's more likely one would rise 40% while another drops 30%. This would likely trigger a 35/15 or 30/20 standard band rebalance anyway.

The biggest downside I see to this change from 35/15 to 30/20 is the loss of momentum investing. If I sell gold at the 30% band to buy stocks, down at 20%, then I risk moving out of the gold position too "early." However, this seems arbitrary and could also be market timing.

Thoughts on this change for my personal situation? From a psychology standpoint, I'm concerned that I really want to rebalance my portfolio from Gold back into Stocks, and am looking for a way to justify it. Then again, if I always pick a 30/20 band going forward, it's not really market timing. I've always been a contrarian investor when I speculated, and always enjoyed selling what was hot to buy what was out of favor. I personally believe the only way the PP makes money is to rebalance, and "lock in" gains.

Finally, there's something cool about the term "30/20-10" meaning rebalance when one asset reaches 30%, or 20%, or the entire PP changes 10% since the last rebalance. 30/20-10 has a cool ring to it

[doodle]

I did a halfway rebalance recently from gold to stocks. I knocked the percentage of gold down to about 28 percent and bought about the equivalent in stocks.

I think I would have been less prone to do this if the move in gold had been slower and more measured.

I feel more comfortable with the tighter bands myself....I'm not sure if 35/15 and 30/20 rebalance bands make an appreciable difference. Has anyone run the numbers on this?

[stone]

I've also pondered along the same lines as you (along with everyone else I guess). The 10% drop in the gold price last January passed by entirely unharvested by my PP because it didn't trigger a rebalancing. I read that US treasuries are (were?) just about the only asset class that did not exhibit any momentum effect (so buying the dips works with US treasuries even over just a one month time scale). With the other assets there is some momentum effect to confuse matters. I don't know whether the 35-15 bands correspond to an optimum for locking in most significant swings and yet not getting on the wrong side of momentum. Supposidly the four PP assets correspond to different economic conditions and so an "economic condition" might be thought to last for more than an instant which is another way of saying that there are momentum effects? Over the last couple of years as far as I can see the underlying economic condition has been the same but every couple of weeks the "markets" stampede in a different direction response to that same economic condition. What matters then I guess is how much momentum such stampedes have. Also always be aware that reducing big losses makes more of an impact than increasing gains does (need to have a 100% gain to make up a 50% loss). Rebalancing more than once into a plumeting asset could increase overall portfolio drawdown which is to be avoided if possible.

[gizmo_rat]

Clive's put a fair amount of work into modeling PP rebalancing

http://www.jfholdings.pwp.blueyonder.co.uk/
6th item in the nav. "rebalancing"

(there's a spreadsheet there for the more adventurous)

and concluded

" By sensibly rebalancing in a manner how Harry Browne suggested there is a greater likelihood of being more in the mid/upper range of overall gain outcome than that of being in the mid/lower outcome set. "

[doodle]

Stone,

I think there is a lot of confusion about what kind of environment we are exactly in, as opposed to previous secular bull markets where one economic condition such as inflation or prosperity ruled the consensus. Today, there is a huge divergence in thinking about wildly different economic outcomes such as inflation vs. deflation. And with the recent huge downward movement in stocks, there is obviously confusion regarding prosperity vs. recession.

These fast and volatile moves in the asset classes take place quickly as people (and maybe more importantly, "machines") jump back and forth quickly between wildly different world views based on sentiment and technical data.  

Our extremely volatile reality might argue for tighter rebalance bands to harvest more of the frenetic up and down action. That is only speculation though. The long run is anyones guess.

[stone]

Gizmo Rat, thanks for the link (and thanks to Clive for putting the work in!).

doodle I totally agree about what you say about the markets now being in a state of confusion. I'd go further and say that the prevailing "economic condition" is one of excess money piling up with no sensible outlet for it (due to deficit spending to pay for tax cuts for the rich). My guess is that that excess money will force ever greater volatility. Perhaps tight rebalancing could harvest more of that but also repeated rebalancing into a black-hole asset class has to be avoided. I'll check out Clive's stuff.

[Storm]

I've also pondered along the same lines as you (along with everyone else I guess). The 10% drop in the gold price last January passed by entirely unharvested by my PP because it didn't trigger a rebalancing.

Stone,

I think this is actually an example of the 35/15 rebalancing bands providing you with a greater return.  If, for example, you had rebalanced back in January, you would have missed some of the gold momentum and upside that has happened in the last couple of weeks.

I admit, the temptation to do an early rebalance is great, especially when treasuries and gold are so high relative to where they were even 1 month ago.  I avoid this temptation by doing constant mini-rebalances.  For those of you still in accumulation phase, this is easier than if you are in drawdown phase:

Every 2 weeks, 15% of my paycheck gets deposited in my 401k brokerage link account.  I just buy the lowest asset.  This has prevented me from hitting any rebalancing bands since I started my PP in 2009.  In a way, these are mini-rebalances because I am always buying low.

[stone]

Storm, sorry for being unclear. I meant the 10% drop in the gold price (as priced in GBP) that happened during Jan 2011. If I had had tight rebalance bands, then I would have purchased more gold in response to that and so had more for the increase from that point onwards (but I guess would also have rebalanced out again more recently which time will give its verdict on in due course).

[Storm]

Storm, sorry for being unclear. I meant the 10% drop in the gold price (as priced in GBP) that happened during Jan 2011. If I had had tight rebalance bands, then I would have purchased more gold in response to that and so had more for the increase from that point onwards (but I guess would also have rebalanced out again more recently which time will give its verdict on in due course).

I see.  In that case, you're right, you might have had some slightly better gains from a bigger position in gold.

[doodle]

Adding too quickly into an asset that is on a longer term downward decline is perhaps not the best choice.

I learned this from the housing market. I bought my house two years after the meltdown at about 50% below what the previous owner paid a few years earlier. I thought I got a great deal with a great interest rate only to watch prices and interest rates continue to decline over the next 2 years.

The lesson I learned is that when a bubble bursts the recovery is very slow and drawn out....more so when the politicians are trying to stem the collapse. When eventually gold collapses I imagine it will reenter a long bear market. People will talk about how such an asset is irrelevant in the new money era. In fact, we probably won't even be using currency at that point. We will just use retina scans at the checkout counter to pay for things....or something like that. Gold will be seen as an antiquated asset in our new "cashless" society.

The question is....will you have the guts to rebalance into this asset at that point?

Like Clive suggests, it might be better to let the bubble deflate for a while until you jump back in.

[melveyr]

Here is the ultimate question. Will you stick to these bands?

Will you use 30/20 rebalancing bands when things settle down a bit more?

Part of me thinks it is best to just follow and stick with a plan. If 30/20 is easier for you to stick with, then go for it. But I would avoid trying to tactically time the Permanent Portfolio. Then you are left with a Fickle Portfolio. Or a Whatever Asset Class I Like I Overweight Portfolio. If you are thinking 30/20, I would contemplate doing it over the life of the portfolio.

Also, do you have a PP? Last I remember you were light in the Treasury department.

[stone]

doodle, I guess what you are saying about a hypothetical future for gold and Clive was saying about gold's 1980-2000 slump could also be applied to stocks  for the 2000-present period. I'm also interested in how damaging gold actually was for the PP over the 1980-2000 period. It was not a smooth decline and the volatility during that period sometimes had a beneficial negative correlation to stocks and bonds. When GBP came off the ERM in 1992, gold got a 25%? price rise as priced in GBP. Such beneficial volatility might mitigate the secular trend. After all, people buy VIX trackers and no one expects those to give long term returns as an isolated asset.

[doodle]

While month to month movements are difficult if not impossible to predict, I think it is possible to observe overall secular bull markets. These bull markets tend to last many, many years. Bonds have been in a secular bull market for about 30 years. Gold has been in a bull market for about 10 now. Stocks have been in a long term secular bear market.

When these markets reverse, I believe you can make the case that the secular bull market that popped will underperform for a while. It certainly won't spring back to life immediately....barring some huge change.

In this case a 20% Variable Portfolio that attempts to jump into a secular bull market after a trend has been clearly established seems to like an idea that might have some merit. When stocks make their comeback, I imagine they will give at least 10 years of good growth. It might make sense to try and overweight them 4 or five years into the bull market as a little speculation.

[craigr]

There is no exact science to the answer. If you are a more jittery sort the 20/30 bands are probably better. If you tend to leave well enough alone then 15/35 will be fine. If you are spooked by the market happenings and are between 30-35 and rebalance you won't hurt anything other than potential taxes if you are exposed to them.

The only thing really is to watch the ultimate high and low sides. Going over 35% begins to really ratchet up your exposure to a sudden market turn in that asset. Going below 15% leaves you exposed in case that asset is needed to buoy the portfolio.

So the short answer is use 20/30 or use 15/35. But don't go higher than 35 or lower than 15. IMO.

[stone]

Craig R, for an Icelandic investor during 2008, would the 20/30 bands have led to significantly greater losses (due to repeated selling of gold and buying of evaporating assets) than the 15/35 bands?

[doodle]

I sold out all 30 year treasuries in favor of a five year bond ladder. I am still painfully waiting for that decision to be vindicated.

[Gumby]

In this case a 20% Variable Portfolio that attempts to jump into a secular bull market after a trend has been clearly established seems to like an idea that might have some merit. When stocks make their comeback, I imagine they will give at least 10 years of good growth. It might make sense to try and overweight them 4 or five years into the bull market as a little speculation.

The percentage would be whatever each individual is comfortable with, but yes, as long as you keep a mental wall between your VP and PP, there's nothing wrong with that. However, it's probably easier said than done given the high volatility of each asset.

[Coffee]

It sounds to me like you guys are trying too hard to time the market?  Which kinda goes against Harry Browne's prime directive about not trying to play the unknown, doesn't it?

[craigr]

Craig R, for an Icelandic investor during 2008, would the 20/30 bands have led to significantly greater losses (due to repeated selling of gold and buying of evaporating assets) than the 15/35 bands?

I don't know. What I do know is that the banking stocks there were going up so fast you'd have been rebalancing out of them into gold. When the reverse happened the gold popped in price over 200% and cushioned (but did not eliminate) the impact. Someone rebalancing significantly reduced the portfolio risk. That's the takeaway. Pick a rebalancing threshold and stick to it.

[sfreeman]

I agree with craig that there's no optimal solution.  that said, here's the HB 4x25 results using
daily data from 8/8/00 through 8/9/11, with annual rebalancing at years end.

35/15 bands
cagr 7.82%
vol  7.16%
max drawdown 14.62%

correlation of HB 4x25 to:
VTI .51
TLT .263
GLD .747
SHY .168
PRPFX .799

35/15 rebalance dates
11/20/08


30/20 bands
cagr 7.63%
vol 7.17%
max drawdown 15.58%

correlation of HB 4x25 to:
VTI .547
TLT .258
GLD .721
SHY .157
PRPFX .801

30/20 rebalance dates
9/19/01
7/19/02
5/2/06
10/3/08
11/19/08
5/27/09

and here's the results of PRPFX for the same period
cagr 11.08%
vol 10.18%
max drawdown 27.16%

[stone]

sfreeman, am I understanding you right that your data is for a PP that gets rebalanced every year come what may (even if it is only 26:24:25:25) and then gets supplementary rebalances if, despite the annual rebalance, it nevertheless becomes so unbalanced that the 35/15 or 30/20 bands get hit?

[sfreeman]

Stone, that is correct.  for Jan 1, each year, the portfolio is rebalanced to 4x25, regardless of the weights at the end of the year.  and if during the year either of the bands is hit, then each asset is brought back to a 25% weighting.

[MediumTex]

Stone, that is correct.  for Jan 1, each year, the portfolio is rebalanced to 4x25, regardless of the weights at the end of the year.  and if during the year either of the bands is hit, then each asset is brought back to a 25% weighting.

I don't think that in the history of the PP a 15/35 rebalancing band would be hit within 12 months of setting it up.  By rebalancing at the first of each year, I think you are foreclosing the possibility of seeing a rebalancing event due to hitting a rebalancing band.

[craigr]

Stone, that is correct.  for Jan 1, each year, the portfolio is rebalanced to 4x25, regardless of the weights at the end of the year.  and if during the year either of the bands is hit, then each asset is brought back to a 25% weighting.

I don't think that in the history of the PP a 15/35 rebalancing band would be hit within 12 months of setting it up.  By rebalancing at the first of each year, I think you are foreclosing the possibility of seeing a rebalancing event due to hitting a rebalancing band.

I tend to agree with this as well. I will look at the end of the year for rebalancing for tax reasons and if it is a good opportunity I may do it. But overall the fewer transactions in the portfolio the better which is what the 15/35 bands allow you to do. I will keep closer tabs on things when I know the markets are going bonkers as well just to make sure a band isn't blown through unnoticed.

[TripleB]

Also, do you have a PP? Last I remember you were light in the Treasury department.

I've been 100% full PP, no VP, for over one year. Maybe 2 years now. I don't remember exactly. I wound up buying 30 year treasuries at auction from VG last year, after deciding I didn't like VUSTX for the bond position due to the shorter duration.