What is the best thing you can do to improve your clients’ portfolio performance? For a long time, the accepted answer was simple: asset allocation. Now, however, it appears that there is a second factor that might just be more important: consistency in that asset allocation, as maintained by steady rebalancing.

In 1986, a notable research paper concluded that asset allocation was the most important determinant of portfolio returns. As it happens, the last decade and a half has offered confirmation of the validity of this theory.

In the 15 years that ended on Dec. 31, 2013, returns for U.S. stocks, international stocks and bonds were relatively close. Using the three lowest-cost index funds that existed 15 years ago as proxies for these asset categories, investors would have realized these returns:

  • Vanguard Total Stock Index (VTSMX): 5.38% annual return.
  • Vanguard Total International Stock Index (VGTSX): 5.15%.
  • Vanguard Total Bond Index (VBMFX): 5%.

Looking at these results and using the brilliance of hindsight, it might appear that owning a portfolio of all U.S. stocks would have been the optimum choice — yet it doesn’t quite work out that way.

The “Allocation Options” chart above on this page shows three different versions of a portfolio consisting only of these three funds: a very aggressive mix made up of 90% stocks and only 10% bonds, a moderate blend of 60% equities and 40% bonds, and a conservative portfolio of 30% equities and 70% bonds. (All three split the equity portion with two-thirds domestic, one-third international.)

As shown in the “Comparing Three Allocations” chart below, it turns out that the three portfolios, rebalanced every June 30 and Dec. 31, performed almost identically.

Note a surprising detail: Even though bonds were the lowest-performing asset class, the moderate portfolio — in which 40% of the assets were bonds — actually bested the aggressive portfolio, which held only 10% bonds.


A more important finding turns up in the “Annualized Asset Returns” chart below: All three portfolios outperformed each individual fund.

Further, the rebalanced moderate portfolio outperformed a static buy-and-hold portfolio — by an extra 54 basis points annually, for instance, in the case of the 60% stock portfolio. The conclusion is that being consistent in asset allocation was even more important than picking the right allocation in the first place — at least for the past 15 years.

We can see the effect of rebalancing using the moderate portfolio (with 60% stock) and a $100,000 initial investment over the 15-year period.

Let’s say one investor rebalanced the portfolio twice annually, at the end of every June and December and another set the allocation at the beginning and never touched it again.

The results:

  • Rebalanced semiannually: 5.72% annualized returns, for a $130,334 gain.
  • Static: 5.18% annualized returns, for a $113,303 gain.

Both of those assume relatively disciplined investor behavior. But research shows the average individual investor pays at least a 1 percentage point penalty each year for poor timing — so you could also assume that an investor who wasn’t rebalancing, but was instead changing the allocation to chase performance, made only 4.18% annually.
That would work out to a more modest $84,827 gain over that same period — 35% less than the rebalanced portfolio, and 25% less than the static allocation. It’s easy to place the blame on individual investors, but planners are not immune from such poor market timing.

According to data released by TD Ameritrade, advisors on its platform averaged only 26% in cash and fixed income on Oct. 9, 2007, the pre-crash market high — and had a whopping 51% in cash and fixed income on March 9, 2009, the recent stock market bottom.


For those who think the past 15 years were unforeseeable, consider some articles written back in 1999 and 2001 by Wall Street Journal personal finance columnist Jonathan Clements (who returned recently after six years at Citigroup).

At the time, he noted the benefits of rebalancing a portfolio’s weighting of stocks versus bonds, and quoted the financial theorist William Bernstein as saying that “a rebalanced portfolio may actually do better than the two assets on their own, because rebalancing forces you to buy low and sell high.”

Indeed, Bernstein says that rebalancing is the only form of market timing that works.
I recently showed Clements the data in this article. He noted that investors and advisors have no ability to forecast returns in the short run.

Keeping a constant asset allocation should actually be thought of as a risk-control technique, Clements says. Since stocks are riskier than bonds, maintaining a fixed percentage of high-quality bonds keeps a portfolio’s risk more constant.

In addition to controlling risk, rebalancing gives advisors and their clients a boost from the phenomenon known as reversion to the mean, Clements says. After all, stocks won’t always have the double-digit gains they have averaged over the last five years; nor will bonds always lose value as they did in 2013.

In short, rebalancing lowers the annual standard deviation of the entire portfolio and results in a higher compounded return.


But many clients may not be receptive to math lessons. And of course, it’s not always easy to ignore economists’ repeated forecasts of increasing rates and a looming bond bubble. (Although people do manage to ignore the data showing that these same economists have a poorer than 50% track record of getting the direction of interest rates right.)

Clients expect financial planners to have insights into the future. How much will interest rates rise with the tapering of quantitative easing? What impact will tapering have on stocks, both in the U.S. and Europe? Will gold regain its mojo?

I freely admit to my clients that I don’t know the answer to these questions. Then I ask them if they know something the market doesn’t already know.
For example, I’ve often argued that markets aren’t oblivious to the fact that the U.S. Treasury can’t continue to buy back our own securities indefinitely. Yet as rates rose, the herd pulled $41.1 billion from the PIMCO Total Return fund in 2013. That was a record for annual withdrawals from any fund.

Clients don’t consciously decide to chase performance, yet that’s exactly what investors’ instincts lead them to do. When the news raises the possibility that the euro will collapse, the tendency is to want to get out of European stocks.

Most people think that adjusting an investing strategy is a logically thought-out decision, based on sound economic principles. In reality, when people invest based on common knowledge, they are swimming after a ship that has already sailed — and that doesn’t usually end well.

While no one knows what the next 15 years in the stock market will be like, it is unlikely (but not impossible) that bonds will keep pace with stocks. That’s partly because stocks typically outperform bonds over long periods of time, and also because rates can’t decline in the next 15 years as much as they have over the last 15.

The role of bonds in a portfolio, after all, is that of shock absorber; never forget that stocks are riskier in a day than bonds are in a year.


Sticking to an asset allocation may not again outperform all three asset classes. Yet this consistent approach is likely to improve returns over even a static allocation that averaged the same percentages for each asset class over the 15-year period.

Rebalancing to keep asset allocations consistent has worked brilliantly for the past 15 years. Your job as a planner is to explain to clients why this approach is likely to continue to work over the long term.

I tell clients that it’s math over emotion. It’s easy to think we know the future; it’s far more difficult to accept the painful reality that none of us actually does.

There is a silver lining to that painful reality: Over the past 15 years, the portfolio that stuck to its allocation earned 1.54 percentage points more each year than the average portfolio that tried to time these asset classes.

I suspect the disciplined, rebalanced portfolio will continue to beat the typical dollar-weighted, poorly timed portfolio by a similar amount over the next 15 years, as well. FP

Allan S. Roth, a Financial Planning contributing writer, is founder of the planning firm Wealth Logic in Colorado Springs, Colo. He also writes for CBS MoneyWatch.com and has taught investing at three universities.

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