Siren Songs

Capturing Portfolio Returns: Simple but not Easy

Disclaimer: This article contains information that was factual and accurate as of the original published date listed on the article. Investors may find some or all of the content of this article beneficial but should be aware that some or all of the information may no longer be accurate. The information and/or data in this article should be verified prior to relying on it when making investment decisions. If you have any questions regarding the information contained in this article please call IFA at 888-643-3133.

Siren Songs

Throughout the IFA Website, you will find long-term historical returns of the IFA Index Portfolios and the asset classes that make up those portfolios. One example is the table of Simulated Passive Investor Experiences shown below for Index Portfolio 60. The highlighted line on the table summarizes all of the ten-year rolling periods that occurred over the last 50 years.

 Portfolio 60 SPIEs

To more fully understand the importance of maintaining investment discipline, we will focus on the specific passive investor (let’s call him Joe) who started on 1/1/1973—just in time to catch the infamous bear market of 1973-1974. In those nasty first two years, Joe suffered a total loss of 23.45%, which shrank an initial $100,000 investment to $76,554. Adding insult to injury, Joe would have rebalanced his portfolio after the initial 12.24% drop in 1973 by selling bonds and buying stocks. By the end of 1974, after a 12.77% drop, Joe must have felt like a complete schmo for having thrown good money after bad. When Joe’s advisor told him that he should rebalance yet again, one could understand if Joe may have felt somewhat reluctant.

Of course we know that in hindsight, Joe’s advisor was correct, and following a disciplined rebalancing in the next eight years would have netted him an overall annualized return of 11.32% over the whole ten-year period and his initial $100,000 investment would have grown to $292,212. If Joe had decided to take a "wait and see" approach to the proposed 1/1/1975 rebalance, it would have been quite costly, for while the equity portion of his portfolio returned 48.49% in 1975, almost half of that gain came from January alone. There are a couple of lessons we would like to draw from this specific passive investor experience.

First, although there are times when it works beautifully for investors such as 1/1/1975, the purpose of rebalancing is not to maximize returns but to control risk. When a portfolio is allowed to simply drift, there will likely come a point in time where the risk exposure of the portfolio no longer lines up with the risk capacity of the investor, leading to a higher likelihood of the investor abandoning the portfolio which could be very costly. Second, rebalancing can present a psychologically difficult hurdle, regardless of which direction the market has gone recently. This is where the value of a good advisor becomes apparent. An investor who has the benefit of an experienced behavioral coach is more likely to stay the course and not capitulate in a bear market or double down in a frothy bull market, and the ability to avoid a bad decision can pay for the services of the advisor for many years to come.

While we focused on one period that seems like a lifetime ago, there are many others that would have worked just as well. For example, the ten-year period starting 1/1/1995 saw a great bull market inspired by new technology (mobile communications and the Internet) only to experience the worst crash since 1973-74. Investors who were advised in the late 1990’s to pare down their equity exposure found it incredibly difficult. After all, were we not on the cusp of a new era where the business cycle was irrelevant and the Dow was on its way to 36,000? A more recent period with a similar rise, fall, and recovery is the ten-year period from 1/1/2004 to 12/31/2013. Again, obtaining the 7.1% annualized return of a Portfolio 60 required rebalancing on 1/1/2009, after a 45.3% drop in the equity portion of the portfolio and when all the pundits were talking about the imminent arrival of a second Great Depression. Adding insult to injury, the two months after after buying equities saw an additional 21.47% drop in value. We at IFA distinctly recall how difficult it was for clients (and even ourselves) to rebalance during that turbulent period.

Vanguard Research recently published a whitepaper1 explaining the components of advisor’s alpha, a term they coined to describe the value added by passive advisors who adhere to the principles of controlling costs, maintaining discipline, and tax awareness. While Vanguard assigned an overall value of 3% to advisor’s alpha, they estimated the value of behavioral coaching to be 1.50% and the value of disciplined rebalancing to be 0.35%. The latter figure was identified by comparing the 54-year risk and return characteristics of a standard 60/40 non-rebalanced portfolio to a rebalanced 80/20 portfolio. In Vanguard’s view, the value of behavioral coaching goes well beyond rebalancing, and we at Index Fund Advisors would wholeheartedly agree with that.

If you have any questions or would like to learn more about IFA’s approach to rebalancing, please drop us a line at [email protected].


1Kinniry, Francis M., Jr., Colleen M. Jaconetti, Michael A. DiJoseph, and Yan Zilbering, 2014. Putting a Value on Your Value: Quantifying Vanguard Advisor’s Alpha.  Valley Forge, Pa.: The Vanguard Group.