Open in app Joel White C >) 17Followers About { Following ) XN S A Concise Guide to: Market-Beating Investing with Portfolio Rebalancing ©@ -ceiwnite dec28, 2015 - 6 minread Saf Aseries of practical posts that quickly get to the heart of trading techniques, explaining tried and tested methods with none of the padding. Most writing about investment is packed with biography, psychology, economics, opinion and drama. This is often entertaining but can obscure the strategies themselves. The approaches explained here have been extensively back-tested and some form part of the author’s* live trading system, but be warned: this is not financial advice. Any investment can lose you money. ANote on Jargon: the technical language in this article is explained in the glossary at the bottom of the page. Summary: Compared to many other strategies this portfolio rebalancingOpenin ape @ni trades well, notably even throughout the 2008 crash. Running it on a diverse basket of 3 Exchange Traded Funds (ETFs) is profitable, and superior to buying and holding the underlying ETFs. The portfolio tested here contains a Real Estate Investment Trust (REIT), a total bond market tracker and a world equity index tracker. It doesn’t do as well as just holding the REIT — but how could this top performer have been predicted? I trade an equity ETF version of this which has averaged 17% a year, albeit in favorable market conditions. Rebalancing is a portfolio management technique often deployed to ensure that a fund’s capital continues to be correctly divided between asset classes as the components change in value over time. This is done by selling some units of the best performing asset class(es) and using the proceeds to buy more of the worst performing, returning the portfolio to its original proportions. For example, imagine a simple fund containing 50% Microsoft and 50% Apple shares. Over the course of a year Apple’s price might grow faster than Microsoft's, leaving the portfolio overbalanced 55:45 in Apple’s favor. The manager would sell some Apple and buy some Microsoft, returning the ratio to 50:50. A positive side effect of rebalancing is that you are automatically taking profits while buying into discounted assets. Over time this means your portfolio is not just diverse, but that you are locking in profits and buying cheaply, likely increasing overall returns. Of course, prices can go down because a company is beginning to fail. But in the case of index tracking instruments like ETFs the chance of a price drop being terminal is remote. A fall to zero would mean that many of the most significant companies of an economy have failed. If that happens we have bigger problems than the state of our pensions. The author who introduced me to this system turned a teacher’s salary into a multi- million dollar fortune (see Recommended Reading, below). He suggested choosing a set of different and complementary ETFs which are likely not to be correlated, such as the bonds, real estate and equities I have modeled. However I have also found this to be effective on single asset classes, although this approach carries a substantially higher risk / reward profile. In this test we rebalance once a month but it also works well if you trade just once aOpen in app @niOpen in app @niOpen in app @niOpen in app quarter, or even once a year; suiting people with little time or inclination for trading. The Results The system was back-tested on three index tracking ETFs: the Vanguard Total World Stock ETF (ticker: VT), the Vanguard REIT ETF (VNQ), and the Vanguard Total Bond Market ETF (BND). Vanguard was chosen for their low fees and availability of back test market data. Data for all three start in 2008. There was no curve fitting, or rather there was no experimentation with alternative constituents to find better results. Brokerage fees and taxes are not taken into account. The portfolio was rebalanced every month. Total Trades: 95 Total Up Months: 58 Total Down Months: 37 Win Percentage: 61% Lose Percentage: 39% Percentage of time in the market: 100% Annualised ROI: 7.54% For comparison: REIT annualised ROI: 9.51% Bond market annualised ROI: 4.46% Equity tracker annualised ROI: 4.78% Average (buying and holding in equal proportions): 6.40% Conclusion The back test shows that for this basket of ETFs the system out-performs a simple “buy and hold” investment divided equally between the three products. It doesn’t beat investing in the REIT alone, but this trade would have been much riskier andOpenin ape @ni contrasting asset types, but can also improve returns on riskier portfolios, for example exclusively equities ETFs. The author has used the latter approach to yield 17% annualised returns. Recommended Reading The naire Teacher by Andrew Hallam. An invaluable resource for anyone interested in portfolio rebalancing, making the most of market declines, and only trading infrequently. Hallam made his millions from a teacher's salary with this technique, albeit helping himself along by practicing radical frugality. Glossary Index trackers are products which attempt to simulate the performance of an entire index, such as the FTSE 100 which contains the 100 largest and most actively traded shares listed on the London Stock Exchange. An index tracking Exchange Traded Fund is a derivative product which is freely traded on one or more exchanges. A fund manager, such as those employed by Vanguard, will distribute the ETP’s capital between the constituent stocks of the relevant index. They will buy and sell as companies enter and drop out of the index — for example, if a company grows large enough to join the FISE 100 they will invest in it, while selling the stock of the company that has dropped out. In this way, the the “price” of the entire index, providing a convenient way to invest in the index without having to buy all of its stocks and keeping the portfolio up to date as proportions and constituents change. In return, you can expect to pay a small fee to the fund manager — far less than you would to an active manager, such as those 's price should closely shadow employed by many hedge funds, who you hope will earn their money by selecting stocks which outperform the market. It is fiendishly difficult for the ETF’s manager to exactly mirror the index, so there will be a small tracking error, meaning the price at any given time may be slightly higher or lower than the index it is mimicking. While an equity (ie stock or share) index ETF will copy the performance of a stock market index, a Real Estate Investment Trust invests in a large number of commercial and retail properties. Buying a unit of this is like simultaneously buying tiny pieces of hundreds (or thousands) of properties. Spending your money on this rather than, say, a single house, allows you to profit from a rising property market,Openin ape @ni aims to invest in many bonds, exposing you to the rises and falls of the entire market rather than a single bond. A bond is “a debt investment in which an investor loans money to an entity — typically corporate or governmental — which borrows the funds for a defined period of time at a variable or fixed interest rate.” (Investopedia) *A note about the author: Joel has worked in the capital markets since graduating. He is an investor, technical writer and software developer, but not a financial advisor. Please test these systems for yourself and seek professional advice before risking your money. Next Up Massive equities profits with momentum trading Previously Investing ¥ Finance T. Trading About Write Help Legal Get the Medium app C4 App Store ono