Why Bogle Doesn't Bother to Rebalance

I've admired Vanguard founder Jack Bogle for a long time. In my eyes, he was instrumental in bringing on a revolution in the financial industry that led to low-cost ways for small investors like me to put their money to work in a huge array of markets. Without the index funds he helped pioneer, investors would likely have paid quite a bit more in fund management fees and other ancillary costs.

But in a recent discussion with the Fool's Robert Brokamp, which appears in the brand-new issue of Motley Fool Champion Funds, Bogle said something that surprised me quite a bit: He hasn't rebalanced his portfolio in years. After adjusting his asset allocation during the bull market of the late 1990s, he largely left his portfolio alone, as the roller-coaster ride of the last nine years took stocks down, up, and down again. He's comfortable with the small allocation of stocks he has now and thinks he'll keep it, regardless of which direction the financial markets move in the future.

Why not rebalance?
In general, I'm a big fan of rebalancing. The idea just makes intuitive sense. When a portion of your portfolio has gotten more expensive compared to another, selling something when it's up in order to buy more of something else that's down meets the "buy low-sell high" test, especially for investments that tend to move up and down in cycles over time.

But Bogle's comment serves as a good reminder that rebalancing blindly isn't smart either. Before you rebalance your portfolio, you should understand exactly why you're rebalancing -- and what impact it will have on your overall portfolio. So, here are some reasons why you wouldn't want to rebalance:

  • Changing investment goals and risk tolerance. Typically, investors become more risk-averse on the risk/reward scale as they grow older. Although recent declines in the stock market have caused many investors' portfolios to have below-normal allocations to stocks, that might be exactly what you want if you're close to or already in retirement. If so, there's no need to rebalance.
  • Costs. With no-load mutual funds, rebalancing usually costs little or nothing. But if you have to pay high commissions or sales charges to switch, then rebalancing may not be worth it.
  • Sector rebalancing. The implicit assumption behind rebalancing is stocks that have fallen are more likely to bounce back in the future, while rising stocks are more likely to give up some of their gains. But if you don't think that's the case, then rebalancing isn't the right move.

Here's a simple example of that last point. In 2007, financial stocks fell sharply, while defensive stocks like consumer staples and low-end retailers did fairly well. Because financials were down, you might have rebalanced some of your money away from defensive issues back to the financials.

Yet as it turned out, that would've been a bad move. The run of outperformance for defensive stocks was far from over at the beginning of 2008. Here's how those stocks did last year:

Stock

2007 Return

2008 Return

Bank of America (NYSE: BAC  )

(18.9%)

(63.1%)

Citigroup (NYSE: C  )

(44.7%)

(75.7%)

Morgan Stanley (NYSE: MS  )

(20.3%)

(68.7%)

Johnson & Johnson (NYSE: JNJ  )

3.6%

(7.8%)

Wal-Mart (NYSE: WMT  )

4.9%

20.0%

Procter & Gamble (NYSE: PG  )

16.6%

(13.8%)

McDonald's (NYSE: MCD  )

36.4%

8.5%

Source: Morningstar.

Sure, even some of the defensive stocks lost money. But you lost a lot less than you would have if you'd rebalanced into financials at the beginning of 2008. So, if you don't have confidence that a down-and-out sector is done falling, then rebalancing isn't necessarily the right move.

Who needs to rebalance?
Arguably, the younger you are, the more impact rebalancing your portfolio has. Because stocks tend to be more volatile than bonds, investors with large stock allocations see their respective percentages move around more than those with lots of more stable bonds in their portfolios.

Also, if your goal is to invest more conservatively over time, then it's more important to rebalance when stocks have posted big gains than during a bear market. You want to lock in gains when stocks do well, but adding more stocks when they fall is less important.

Deciding whether to rebalance is essentially making a bet on how you believe stocks and bonds will perform. If you think falling stocks are giving you an opportunity for future profits, then you won't want to follow Bogle's advice.

For more on mutual fund investing, read about:

To see more of Jack Bogle's advice to fund investors, read this month's new issue of Champion Funds. A free 30-day trial to the service will let you view the Bogle information, as well as get full access to all the resources our fund newsletter has to offer.

Fool contributor Dan Caplinger still rebalances with a fair amount of success. Wal-Mart is a Motley Fool Inside Value selection. Bank of America is a former Motley Fool Income Investor pick. The Fool owns shares of Procter & Gamble. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy is always in balance.  


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  • Report this Comment On January 29, 2009, at 8:12 PM, SteveTheInvestor wrote:

    I've been re-balancing over the past year. I'm up to about 75% cash (was 10% prior to that). Had I been dumb enough to move more money into stocks, my net worth would be far lower than it is now. Likely a 10 year period would be needed just to break even.

  • Report this Comment On January 30, 2009, at 2:02 AM, BruceBenson wrote:

    The reason I don't rebalance often is that it can just become a form of timing the market, which is a bit anti-Bogle. For example, my planning assumption is an overall long term 8% for my index fund. So assuming long term and 8% then why would I try and rebalance when the market bounces up and down? It is expected to do that. So when do I look at rebalancing? Either when my situation changes (changing my risk acceptance) or about every 5 years. Why 5 years? Because in my case and with my allocation it will take about 5 years for the individual allocations (stocks, bonds, etc.) to get more than 5% out of balance if they did nothing but grow at their average rates (which they should eventually average out to). I've never found this approach discussed anywhere.

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