The Advantages of Diversification and Rebalancing
Diversification and regular portfolio rebalancing provide measurable benefits to investors. This statement holds true even though the last decade bought two bear markets for stocks and the outlook for the future is currently anything but certain.
I realize that saying diversification and rebalancing help may surprise some of you. The roller-coaster ride stocks have been on and the portfolio devastation experienced by many investors has created a great deal of skepticism about whether the cornerstones of portfolio management still work. Yet the data shows that they do in fact work.
In this article
- The Portfolios
- The Mutual Funds
- Portfolio Construction & Management
- Performance Results
- Are There Alternatives?
- How Your Age Affects Diversification and Rebalancing
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To prove this point, last December I created a simple portfolio consisting of $50,000 in the Vanguard 500 Index (VFINX) and $50,000 in the Vanguard Total Bond Market Index (VBMFX) mutual funds. I ran the numbers as if the portfolios had been held during the “lost decade” of 2000 – 2009. As some of you may remember from my commentary in our weekly AAII Investor Update e-newsletter on December 16, 2010, there was an advantage to annual rebalancing.
Though the simplicity worked to prove a point, advocates of diversification suggest that investors hold more than just large-cap stocks and bonds. Plus, I received e-mails from members asking what would happen if other assets were included. So, I decided to expand the number of funds included in the portfolio and rerun the numbers. As you will soon see, a diversified portfolio would have given better returns. Rebalancing on a regular basis (e.g., annually) would have lowered the volatility of the fully diversified portfolio, making for a winning combination.
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