Monday, March 14, 2011

Robust Rebalancing Rules

Investment Lesson #4

To maximize your returns and minimize your risks, you MUST rebalance your investment portfolio as needed. Rebalancing prevents any asset class from getting too large or too small; it captures gains from the mindless fluctuations of the markets; and it lowers your risks with countermoves to market volatility.

BUT we do NOT rebalance continuously, every day or week. We wait for the asset classes to get significantly out of line. And we give the classes room in time and price to make significant moves. We also cap certain rebalancing actions. The basic rebalancing rules (#1 and #2) provided below are simple enough, but the exceptions (rules #3-5) are where you need to pay attention.

Rebalancing Rule #1

If an asset class gets more than 5% away from its canonical share of your portfolio, buy or sell (or exchange) enough to put it back in line. Example: US Stocks rise and now US stocks represent 31.5% of your total portfolio value. Sell some index funds or VTI to bring it back to 30%. Buy whatever is low, or if nothing is significantly low, put the money into cash to wait for something to get cheap.

Rebalancing Rule #2

For asset classes that are rising, do this every time the class gets out of line.

Rebalancing Rules #3

For asset classes that are falling, after one 5% rebalancing, wait. The next rebalancing should be done (A) if the asset class gets an additional 10% too small, or (B) after six months if it is just meets the 5% test.

Rebalancing Rule #4

For asset classes that continue to fall, wait. The third and LAST rebalancing should be done (A) is the asset class gets an additional 20% too small, or (B) after one year if it just meets the 5% test.

Rebalancing Rule #5

No more for now, regardless of whether the asset class continues to fall. Three strikes and you sit down and wait at least two years. That asset class might be in a multiyear collapse and bear market like Japan suffered in the later 1980s and early 1990s, or as gold & silver suffered in the early 1980s.

DO NOT KEEP putting money into an asset class that keeps falling - this is a rule required to robustness of the model - to prevent a catastrophic loss of funds. Theoretically, if a market keeps dropping and you do NOT cut off the rebalancing towards it, that falling class will consume all your money, like a black hole consumes everything the gets into its clutches. Stop after three swings and sit down awhile. Let the dust settle.


These rules provide you simple instructions to buy low, sell high, and sell high, buy low. Think of all those times you hear that prices are low and it's time to buy. If you don't sell something at high prices, you won't have any money to buy when prices are low.

Use cash as a buffer if nothing is cheap. Then when an asset class falls in prices, swoop in and scoop up some cheap shares.

The cut-off rules prevent your portfolio from unduly suffering if one or more asset classes fall too dramatically. Obey them. Don't be a hero ... or a pig.


I will monitor Krypto Fund closely, the large fall in Japanese stocks might provide a buy signal in my Pacific stocks.

Word of the Day

"Behoove" - verb, transitive [$10] British 'behove' with the 'o' as in no.
Behoove means 1. (preceded by 'it' as subject) (formal) be incumbent upon; 2. (usu. with neg.) befit [it behooves him to protest].
Sentence: For the well being of your investments, it behooves you to pay attention to the above rebalancing rules.

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