Jack Bogle: "Never" Rebalance Your Investment Portfolio (and how to do it if you must)

jack bogle the founder of vanguard believed that you shouldn't rebalance a portfolio he had some really good reasons for arguing that frankly you should just leave your portfolio alone and never worry about rebalancing hey everybody i'm rob berger this is the financial freedom show in today's video we're going to take a look at why he believed rebalancing was something you should avoid and there are some good reasons to actually avoid it but we're also going to look at some of the advantages of rebalancing and for those like me who do rebalance their portfolio from time to time we're going to cover a concept called opportunistic rebalancing trust me it sounds a lot fancier than it really is but i think it is the best way to go about rebalancing if you decide that's best for you before we dive into the topic a quick announcement i am launching or relaunching my investment newsletter it starts going out next sunday morning if you're watching this video weeks and months from now it'll be going out every single sunday morning uh packed with information on retirement and investing basically stuff that can help you make the most of your money particularly as it relates to to retirement so if that's something of interest to you you can check out right below this video is a link where you can sign up for the newsletter it's free and worth every penny all right jack bogle why in the world did he not want us to rebalance our portfolio well let me actually show you on the screen here this is an interview that christine benz of morningstar did with jack bogle a number of years ago he's since passed away not too long ago and recall christine bins was on our show she actually uh i interviewed her about the bucket strategy which she's written a lot about but in this interview with jack bogle she was talking about rebalancing and you can see right here he says i am in a small minority on the idea of rebalancing i don't think you need to do it and he says the data bear me out because the higher yielding asset is going to be stocks over the long term now what in the world is he talking about so the idea is this when we think about rebalancing often we think about rebalancing between stocks on the one hand and bonds on the other so for example let's imagine we have a 70 30 portfolio 70 in stock etfs and mutual funds 30 in bond etfs and mutual funds well we might have that just perfect in our 401k ira perhaps taxable accounts and then of course as the market is open and stocks go up and down in price and bonds go up and down in price and pay interest and so on our allocation can deviate from our target and eventually it will deviate by a lot so the idea of rebalancing is simply to uh sell your winners sell the asset that's gone up in value and use the proceeds to buy the asset that's gone down in value and the point that jack bogle was making is that over the long term stocks have a higher expected return than bonds so if we're constantly rebalancing between stocks and bonds to keep it at our target asset allocation say 70 30 or whatever your allocation may be his point was over the long term you're actually going to see lower returns and that may surprise some of you if you've not given this much thought until now and what i want to do is actually show you with portfolio visualizer what this looks like so here is portfolio visualizer and you can see i've created a portfolio sixty percent u.s stock market forty percent bonds we could have used a different allocation but this is fine for now and portfolio visualizer lets you model different rebalancing approaches and we're going to start with annually which i think is probably the most common for individual investors certainly not the only reasonable approach if we analyze this portfolio we can see that from 1972 to 2021 so we'll call it 50 years 10 000 grew into a million bucks 984 000 that was rebalancing annually i will tell you since i've run all these numbers that between the different rebalancing approaches monthly quarterly semi-annually or annually quarterly turns out to have the highest portfolio balance at the end you can see here not dramatically higher but about 10 i guess 13 000 higher so just under a million bucks however if we take the jack bogle approach and we say you know what we're not going to rebalance at all what happens to our million dollars well instead we have 1.1 million dollars so at least based on this 50-year period and the 60-40 portfolio that i've put into portfolio visualizer jack bogle it was absolutely right rebalancing to keep the portfolio at a 60 40 allocation still has a great outcome i mean ten thousand dollars into a million bucks ain't bad but had you not rebalanced uh you would have had uh 1.1 million dollars instead now that's not the end of the story as you might imagine and there are some really good reasons i think to rebalance we're going to get to that in a minute but there's one other thing that jack bogle pointed out about rebalancing particularly for those like me who have investments in taxable account and that is that rebalancing can trigger taxes and that can be yet another reason to avoid rebalancing so in addition to uh dampening returns as you sort of keep your asset allocation between stock and bonds you know consistent again in our example 40. on top of that the potential taxes that rebalancing can trigger trigger he was of the view yeah you shouldn't rebalance he was happy to just leave the portfolio alone and let it drift wherever the markets took it that was his approach now having said all of that i think that there are still some really good reasons to rebalance and the first one is this you pick an asset allocation that is stocks to bonds for a reason right you maybe your allocation is 70 30 80 20 90 10 whatever it might be you've picked that for a reason in part because it was the risk the volatility that you could tolerate you didn't want to risk your portfolio if for example you chose 80 stocks and 20 bonds there was a reason you avoided a 90 10 portfolio or a 100 percent stock portfolio and rebalancing between stocks and bonds allows you to keep the portfolio that you originally intended rather than letting stocks sort of overtake the portfolio over time and move you into a riskier more volatile asset allocation and let me show you what that looks like we'll go back to portfolio visualizer and we can all look at this 1.1 million dollar number yes we i think we'd all agree that's a better outcome than the million dollar number but we have to recognize there's no free lunch and if we look at the assets of this portfolio we can see right here this section it's portfolio return decomposition when we look at the portfolio at the end of the 50 years we can see that the u.s stocks account for about a million dollars and bonds account for about a hundred thousand so what does that mean it means that the portfolio started 60 40 60 stocks 40 percent bonds but but when we didn't rebalance it drifted all the way up to 90 stocks roughly and 10 bonds in other words it became a lot more risky of a portfolio its volatility was much more significant as a 9010 portfolio than a 60 40 portfolio now again there's nothing wrong with the 9010 portfolio and in fact uh i used that rough allocation for many years but if that's what you want why start with 60 40. right just start with 90 10 why start with 60 40 and then let your portfolio drift if you want a 60 40 portfolio because that's the risk that you think you can handle then what rebalancing between stocks and bonds will do is maintain that risk profile for you and perhaps you're willing to forego some potential higher returns in exchange for a less a volatile portfolio that's the first thing that i think is in favor of rebalancing the second thing relates specifically to retirement i am not a believer of a 100 stock portfolio frankly that's generally true even when you're accumulating money for retirement but certainly in retirement i just think it's far too risky and i don't want my portfolio drifting in that direction in my case we're currently roughly 80 20 sort of gradually probably moving to more like 70 30 over time but once i've got that poor that allocation locked in i don't want it drifting higher i want that 30 of fixed income and cash because uh that gives me security that gives me money to spend in the in the near term that's what the cash is for uh i don't follow the bucket strategy i rebalance based on percentages and we'll come to that in a minute but i want that fixed income to help me as i spend money in retirement now having said that there are some that have argued even in retirement you should let your portfolio drift uh and have it become riskier over time that's a topic for another video but i can tell you michael kitzes uh and dr wade fowle have both proposed that option so it is out there it's just not one that i have at least so far embraced the third thing and that's this the concept about opportunistic rebalancing i mentioned that at the beginning of the video you can actually increase your potential returns with a certain type of rebalancing now remember jack bogle was talking about rebalancing between stocks on the one hand and bonds on the other and that's important to understand because stocks have a very high expected return as compared to bonds fair enough but what about rebalancing between different stock asset classes for example rebalancing between a u.s stock index fund and an international uh stock index fund or between a developed international markets index fund and emerging markets we could add in small cap we could add in reits maybe commodities for some of you what about rebalancing between these stock asset classes that all have fairly high expected returns certainly when compared to bonds well what the studies show is that if you rebalance in the right way you can actually uh potentially no guarantees as we know but potentially increase uh your returns and that gets us to the concept of opportunistic rebalancing now to put it into some context one way to rebalance as we saw with portfolio visualizer is to just do it based on time every quarter rebalance or you know twice a year when the times change and you change the battery and your smoke detectors you could rebalance or perhaps once a year you could rebalance the problem with that approach is one you may not need to rebalance maybe your asset classes haven't deviated that much and rebalancing just because it's the end of the year may not always be the best also when we have significant uh bear or bull markets like for example we had the the bear market from the the pan the cobot pandemic last year followed by a bull market there could have been real opportunities to rebalance during uh those significant swings in the market and if you were just rebalancing once a year you would have missed that opportunity so what opportunistic rebalancing says is look let's forget the time that's not really our main focus it can be part of this but our main focus is let's rebalance when an asset class deviates from our plan by a certain percentage that's the basic idea and the paper on this and i'll show it to you now here it is and i'll leave a link to this below the video and i may do a future video that goes into far more detail on this concept but i'm going to give you enough now so you understand uh the concepts and to understand opportunistic rebalancing we need to understand basically two things what are called rebalancing bands and tolerance bands and so to show you how this works we're going to go to the whiteboard for a second let's imagine we'll just use the three fund portfolio as an example and we'll assume in the three fund portfolio we have u.s stocks and we have 50 percent allocated to u.s stocks maybe it's a vanguard vti etf for example so if we imagine a graph we'll put 50 here this is our allocation and what the paper that i just showed you a moment ago says is this let's do this we're going to add um 20 to to our allocation and we're going to subtract 20 so what's 20 of 50 well it's 10 so we're going to add 10 to this so that would give us 60 percent and we're also going to subtract 10 that gives us 40 and these represent the outer bands what i've called rebalancing bands and what we're going to do is we're going to rebalance whenever our u.s stock allocation either goes above 60 or below 40 percent until then we're going to leave it alone so for example if it's just hovering around here maybe it goes up here and it goes down and does what stocks do we're going to leave all that alone we don't need any of that we're not going to rebalance in that situation we're only going to rebalance when it either goes up and crosses the upper rebalancing band of 60 or maybe it goes down and crosses the bottom rebalancing band of 40 so that's how the rebalancing band works that's what's going to trigger rebalancing now that's the first part of opportunistic rebalancing the second thing relates particularly to taxable accounts and it asks this question if rebalancing gets triggered let's just assume it gets triggered because it goes down so what that means is we're going to sell some other asset class probably bonds in this case but whatever it may be and we're going to use it to buy stocks the question is do we need to get it back up to exactly 50 percent do we need to be really really precise with this and what the author said in the opportunistic rebalancing paper is particularly in taxable accounts absolutely no particularly if trying to get super super precise is going to trigger a bunch of taxes and so what he came up with and others have written about this as well are called tolerance bans and it said okay we don't have to get exactly to 50 in this example but how close do we need to get it's kind of like a game of horseshoes or hand grenades right you know close enough is okay well how close do we need to get and he defined the tolerance bands as half the rebalancing bands so in this case the rebalancing bands were 10 either way so the tolerance bands are going to be 5 either way so i'll just draw a dotted line so this would be what this would be 45 and the upper tolerance band up here would be 55 there you go and so if we're rebalancing particularly in a taxable account remember in a retirement account i suppose you could rebalance back to the penny if you wanted to because you know taxes aren't an issue but for those of you with taxable accounts the idea is we'll rebalance it just so it gets up to this tolerance band if we get to there uh we're okay we don't need to to trigger more taxes to get it all the way up to our target allocation we can just get it within this tolerance band and that's it it's really as simple as that and just to drive the point home and just show you how this works let's use our 20 bonds as another example we would do the same thing we're going to add 20 so what's 20 of 20 it's four so our upper band will be 24 our lower band will be 16 all right it's going to work the same way it's just the numbers are a little different and our tolerance bands will be half right so we can just do dotted lines as an example and this is going to be 22 and this is going to be 18 and that's it and we just monitor our asset classes in the three fund portfolio very very easy to do it gets more complicated as you slice and dice your portfolio for those of you with like 18 different asset classes and funds yeah it's a lot of work which is one of the reasons i prefer simple portfolios but in any event you'll do this for each of your funds each of your asset classes and the nice thing is is that you notice the rebalance bands and tolerance bands either get bigger or smaller depending on your starting allocation and i think that's how it should be and and it's a great way to think about rebalancing and what i do is just monitor my portfolio i'm looking at it you know daily certainly if not at least weekly and i'm looking for opportunities to rebalance when one of my asset classes breaches the rebalancing band and i have a tool that can help you actually do that and we've talked about it before let me show it to you it is right here this is the um investment tracking spreadsheet i've done a separate video on it i'll leave a link to to the article which you can see here this is the article that i've written on my site um with a link to the spreadsheet right here and um the thing i want to show you is this here are where all the holdings go this is just an example and then the tab that's by asset class kind of summarizes all of the holdings and you'll notice that you can put your target asset allocation right here you may or may not have all of these asset classes you might just have u.s stocks international stocks and bonds that's fine but you can put whatever your target allocation is here the the actual allocation is calculated based off of the numbers you see in this sheet and you have to put in how much shares you own of each fund and then what it will do is it'll show you what the difference is and i've put in thresholds and as you can see the thresholds are 10 of the target so 25 for example excuse me not 10 20 so the target's 25 20 of that number is 5 20 of 10 is 2 and so on and the thing i like about the spreadsheet is if the threshold is breached you can see here for example 3.2 percent is higher than 2 it turns red it's kind of a very easy way to see when an asset class has gone above or below your threshold i find this spreadsheet to be the easiest tool i've found to sort of monitor rebalancing you know i love personal capitals dashboard i love their asset allocation tool among among other things but when it comes to rebalancing i actually find that spreadsheet to be a much easier way to go so listen i know i've thrown a lot at you today i hope it's helpful to you as you think through how you want to rebalance who knows maybe you'll take the jack bogle approach and just say i'm not going to bother with it or you may take a very very simplified approach and just rebalance once a year wouldn't be the end of the world or if you're like me maybe the opportunistic rebalancing is a better approach i really think particularly for those with significant investments in taxable accounts you really ought to consider the opportunistic rebalancing approach it's something by the way that jack bogle does mention in fact in the interview that i showed you and i'll leave a link to it below the video he talks about rebalancing bands he doesn't use the term opportunistic rebalancing but it's the same concept well listen i hope this helps if you have any questions at all leave them in the comments below the video be happy to help you out any way i can and until next time remember the best thing money can buy is financial freedom

Channel: Rob Berger

Views: 40,353

Rating: 4.9286985 out of 5

Keywords: rebalancing, opportunistic rebalancing, john bogle, jack bogle, how to invest, asset allocation, rebalancing a portfolio, rebalancing portfolio, rebalancing stock portfolio, rebalancing index funds

Id: sO8SLwDOvCk

Length: 21min 11sec (1271 seconds)

Published: Tue Aug 17 2021