Vanguard's Jack Bogle on Rebalancing: Don't!

Jack (John) Bogle, founder of Vanguard, answers questions on his blog from readers of his book, The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns. Here's what he has to say about rebalancing:

We’ve just done a study for the NYTimes on rebalancing, so the subject is fresh in my mind. Fact: a 48%S&P 500, 16% small cap, 16% international, and 20% bond index, over the past 20 years, earned a 9.49% annual return without rebalancing and a 9.71% return if rebalanced annually. That’s worth describing as “noise,” and suggests that formulaic rebalancing with precision is not necessary.

We also did an earlier study of all 25-year periods beginning in 1826 (!), using a 50/50 US stock/bond portfolio, and found that annual rebalancing won in 52% of the 179 periods. Also, it seems to me, noise. Interestingly, failing to rebalance never cost more than about 50 basis points, but when that failure added return, the gains were often in the 200-300 basis point range; i.e., doing nothing has lost small but it has won big. (I’m asking my good right arm, Kevin, to send the detailed data to you.)

My personal conclusion. Rebalancing is a personal choice, not a choice that statistics can validate. There’s certainly nothing the matter with doing it (although I don’t do it myself), but also no reason to slavishly worry about small changes in the equity ratio. Maybe, for example, if your 50% equity position grew to, say, 55% or 60%.

In candor, I should add that I see no circumstance under which rebalancing through an adviser charging 1% could possibly add value.

This is an interesting contrast to How to Make Money By Rebalancing.

A footnote: Mr Bogle has been an outspoken opponent of ETFs (he believes they lure too many investors into excessive trading). But you could easily implement the asset allocation he mentions above with ETFs -- at a lower cost than using Vanguard index mutual funds -- as follows:

• 48%S&P 500: Shares S&P 500 Index Fund (IVV)
• 16% small cap: iShares Russell 2000 Index Fund (IWM)
• 16% international: Vanguard All-World Ex-US ETF (VEU)
• 20% bond index: Vanguard Intermediate-Term Bond ETF (BIV)

I've used an intermediate term bond fund because that's what Mr Bogle recommends. You can easily survey the alternatives to these ETFs in the Seeking Alpha ETF Selector's listing of Core Building Blocks: Large, Mid & Small Cap US ETFs, Broad International ETFs and Broad US Bond ETFs.

Comments

[MDCigan:]

"Fact: a 48%S&P 500, 16% small cap, 16% international, and 20% bond index, over the past 20 years, earned a 9.49% annual return without rebalancing and a 9.71% return if rebalanced annually. That’s worth describing as “noise,” and suggests that formulaic rebalancing with precision is not necessary."

I'm not sure this really proves anything against rebalancing. First off, the set of asset classes used isn't very diverse. If you used a more comprehensive set of asset classes with more negative correlation like REITs, commodities and precious metals, emerging markets, etc. in addition to just U.S. large-cap and U.S. small-cap, I'd bet the results would be ALOT DIFFERENT in favor of rebalancing.

Secondly, you would want to test different rebalancing strategies in terms of time frame. There is alot of evidence to suggest there is momentum at the 1-2 year time frame, and mean reversion at the 3-5 year time frame. Perhaps rebalancing less frequently then annually would do even better.

As much as Mr. Bogle is respected in the industry, I think it is important to remember he is biased, and I would not accept anything he says at face value without further investigation of the issues.

2007 Jul 16 05:11 AM

[QVM Group:]

Sure would like to see more studies with different asset classes, different rebalancing time frames or different allocation deviation rebalancing points, in taxable, tax deferred and tax exempt accounts. This is such an important question about such a widely praticed institutional methodology. Articles of faith in the method should be validated or disproved by statistical studies.

One thing Mr. Bogle did not talk about is volatility in rebalanced and not-rebalanced accounts. That should be studied at the same time as return.

There must be a professor out there somewhere with the time, skills and grant money to do a top notch study of the question. Perhaps good comprehensive work is out there now that someone knows about that could be referenced in a reply to this article.

In any event, a worthy topic for investment community discussion.

2007 Jul 16 09:43 AM

[Frank Li:]

Yup, I'd also like to see backtesting of the rebalancing rules suggested in Rebalancing Rules (etf.seekingalpha.com/a...), particularly the non-calendar based rules.

2007 Jul 16 01:11 PM

[Try Reading It:]

Have you actually read the study on Vanguard Institutional's website? The conclusion is completely different than your headline. Anyone interested, see here: https://institutional....

2008 Jan 11 12:42 PM

[George W.:]

Typical Bogle distortion. Mantra has always been save by using his low cost funds yet 22bps is just NOISE. He should try some research and review the DALBAR study. Yes rebalancing does increase return. He can also ALWAYS include the downturn in 2000 when he states active management doesn't provide value, numbers prove it does. Maybe he should read before he writes

2008 Nov 17 12:43 AM