What ‘Back to the Future’ Can Teach Us About Portfolio Rebalancing

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The standard 60/40 portfolio featuring a basic mix of US and international equities plus aggregate bonds has returned a cumulative 754% since 1990. Or has it returned 781%? Or maybe 730%?

All three numbers are correct for this standard strategic asset allocation mix. The differences, however, like the devil, are in the details: it depends on when the portfolio was rebalanced.

Think about portfolio rebalancing like Marty McFly purchasing the Grays Sports Almanac when he and Doc Brown traveled to the year 2015, only to have it found by the 2015-version of Biff Tanner after Doc Brown haphazardly threw it out. This led the 2015 Biff to travel back to 1955 to give it to his younger self so he could get rich by betting on sporting events. In essence, this one singular action triggered a chain reaction of events, thereby creating a distorted time paradox and an alternate timeline for everyone involved.

That’s the impact of rebalancing. The players remain the same, but the timeline has been altered. And depending on the frequency, the difference between the returns could be as stark as the difference between the idyllic original Hill Valley in 1985 and the dystopian “Hell Valley” 1985A version.

Splintered return streams due to rebalancing have been well documented in some respects. The turn of the month effect1 has often been showcased, as has the notion of timing luck2and how it can manifest in different return patterns. Yet in my travels and conversations with investors, it rarely comes up—even though this is an aspect investors should be acutely aware of, particularly during the strategy due diligence and performance attribution process.

To demonstrate how disparate the return patterns can be, I ran a few simulations on the standard 60/40 portfolio dating back to 1990. The analysis shows that there’s no perfect rebalancing period and the decision to rebalance can create yearly return patterns that can at times differ by more than 8%. Imagine losing out to a competing standard strategic model by 8% in a given year just because the portfolio was rebalanced quarterly instead of annually.

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