Rebalancing: How Important?

Below are rebalancing results that Bob Warasila recently updated.  As background for this study, we started with eight asset classes and invested $10,000 in each for a total of $80,000 for the portfolio.  The asset classes consisted of the "Big Six," REITs, and International Markets.  In 1989 I did not have easy access to data on commodities, international real estate, etc.  Neither did I consider bonds in this study.

This material is not available for publication elsewhere on the Internet.

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Market Conditions: A Summary for Early June

As the market continues to slide there seems no place to hide.  PCY was up slightly this morning, but even GLD was negative when I last checked.  Here are links to use to check for both broad market conditions and your individual holdings.  Let's first start with a few broad market direction finders.

1) Bullish Percent Indicator

2) High Low Indicator

3) Stocks above 50-Day MA

4) Site for individual holdings beginning with VTI

Schrodinger Portfolio Update

While I have yet to see the May statement for the Schrodinger Portfolio, the following information will not change much as a result of May dividends and interest payments.  Platinum readers will see that the asset allocation plan is on target for all sixteen asset classes.  We do not hold International Bonds in this portfolio, so we are looking at sixteen asset classes, including cash.

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Multi-Asset Class Investing

Multi-asset class investing or multiple asset classes is a title that comes right out of Richard A. Ferri’s excellent book, “All About Asset Allocation.” While my reference is to Ferri's first edition, I would pay the few extra dollars and purchase the second edition.  Nudged by a fellow asset allocation investor, I went back and reread Chapter 4 of Ferri’s book. Hence, the title of this blog entry.  Ferri's book makes my Top Ten list of best investment references. In this entry, using Ferri as a reference, I will lay out the basic principles of why all investors should pay close attention to asset allocation. The material I quote from Ferri can be found in Chapter 4. Here are a few key concepts Ferri lays out in his book. Permit me to quote.

  • Owning multiple asset classes is better than owning one or two.
  • Each new asset class reduces overall portfolio risk. However, one needs to test for correlation values.  Platinum members witness this testing through Quantext Portfolio Planner (QPP) analysis.
  • Low correlation between asset classes is essential.  It is difficult to find asset classes that have low correlations.
  • There are good portfolios, but no perfect portfolios.

I recommend holding from eight to seventeen asset classes in a portfolio. Not every asset class added to the portfolio will reduce risk. We use sophisticated software to determine which asset classes reduce risk. The philosophy behind asset allocation is that one can increase return while reducing risk if one uses a highly selected combination of asset classes. In addition, Ibbotson and Associates conclude that, on average, 100%* of the return of a portfolio is due to how one allocates the portfolio. This is why we, here at ITA Wealth Management, pay so much attention to this aspect of investing. *  Recent research by Ibbotson differs greatly from their original research.  Their most recent research concludes that 75% of the movement of a portfolio is tied to the movement of the broad market.  Of the remaining 25%, approximately 12.5% is related to asset allocation and 12.5% is due to stock selection.  These percentages vary significantly from their former research, yet the recent numbers make more intuitive sense.  What I am waiting on is to hear if any other researchers can duplicate their recent study. One cannot progress very far into the subject of AA before the topic of correlation arises. That is the third principle listed above. Ferri also writes extensively about correlation. Here are three of his points about correlation between asset classes.

  • It is very rare to find low-cost investable asset classes that are negatively correlated or even non-correlated with each other. Most of the asset classes you investigate and ultimately use have some positive correlation with each other.
  • The correlation between asset classes can change. Investments that were once non-correlated may become correlated in the future, and vice versa. Past correlations are a guide, not a guarantee.
  • During a time of extreme volatility, when you want low correlation between asset classes, positive correlation can increase dramatically. After the World Trade Center was attacked on September 11, 2001, all stock markets around the world fell by more than 5 percent. No amount of global stock diversification helped a portfolio during that horrific time.

Asset allocation models are posted each week here at ITA Wealth Management.  Search for the word, Dashboard, and you will find many examples.

While asset allocation and the who topic of diversification is designed to reduce portfolio risk, we find that many of the seventeen asset classes that make up our portfolios are highly correlated.  Therefore, we are using the ITA Risk Reduction model as an additional way to reduce portfolio risk.  Check out the links to this model.