But Can an Elephant Rebalance Asset Classes?

ELEPHANTS

Tamara Hendrickson: ‘The elephant painting is true.’

ETHANOL

Dan Nachbar: ‘[Re Tuesday], not all ethanol is created equal. Corn ethanol is stupid. Cellulosic ethanol is brilliant. The difference is crucial yet you and nearly all other members of the press fail to make the distinction. No wonder scientists get grumpy.’

REBALANCING

Artie Doskow: ‘While listening for the umpteenth time about the necessity of periodically rebalancing one’s portfolio, I was struck by the thought that rebalancing essentially means taking winnings out of your investments that have done the best and putting them into those that have done the worst. Put in those terms, it seems, if nothing else, counterintuitive. What say you?‘

☞ I say: good question, but I’d definitely go with David Swensen (and everybody else) on this, for two reasons.

First, it’s ‘buy low, sell high.’ Right? (Nothing counterintuitive about that.) When an asset class rises in value, you trim it back (selling some high) to beef up your holdings in other asset classes (that are now, relatively, low). It’s a mechanical discipline, like dollar-cost averaging, that over a lifetime tilts the odds in your favor. (It doesn’t work as well in a taxable account; but in a retirement plan, the only thing to watch out for are the transactional costs of switching money around. Which is why index funds under the Vanguard umbrella, say, make sense.)

Second, it is asset classes we’re talking about here, not individual stocks. With stocks, a good rule of thumb – or at least a rule of thumb to consider, especially in a taxable account – is to ‘cut your losses and let your winners ride.’ With asset classes . . . like ‘U.S. Equities’ or ‘International Equities’ or ‘Cash’ or ‘Long-Term Bonds’ or ‘Real Estate Investment Trusts’ or ‘Commodity Funds’ . . . it’s unlikely that the relative advantage of one asset class will just keep gapping ever wider for decades relative to the others (or that an entire asset class would ever become entirely worthless as a stock might).

For whatever reason you decided that you wanted (say) 35% of your assets in U.S. stocks at this stage of your life, why would you increase that percentage as U.S. stocks became relatively more expensive? (‘Hey, Marge! Prices are up across the board – let’s go shopping!’) You wouldn’t. So if you notice that the 35% slice of your pie that was in U.S. stocks is now, because of good gains in the market, 40%, you would sell enough (selling high) to bring U.S. stocks down to the 35% you intended.

By the same token, why would you decrease your intended percentage as U.S. stocks got cheaper? (‘Hey, Marge! There’s a clearance sale at the mall! Let’s avoid it!’) You wouldn’t. So if you notice that the 35% slice of your pie that was in U.S. stocks is now 30%, you’d switch some assets out of your other asset classes to buy enough stock (buying low) to restore the balance of your portfolio.

This is not nearly as much fun as speculating on Borealis or Aldabra warrants, but a significantly more prudent life plan.

Matt Simpson: ‘I was lucky enough to hear an interview with Mr. Swensen on NPR a few years ago just after he published Unconventional Success: A Fundamental Approach to Personal Investment. I read the book right away and have followed his plan nearly to the letter and have not had a financially indecisive day or a restless night since. Very much in the model of John Bogle and Warren Buffett, Swensen seems to be a person of exceptional intelligence, accomplishment, honesty, and public spirit. If investors could actually follow his advice they would find themselves much more relaxed, much more deliberate, and much more wealthy! The only people who would get hurt are the managers of high-priced under-performing mutual funds and their lackeys in the financial service industry.’

YOU GIVE HIM 39 MINUTES, HE’LL GIVE YOU PERSPECTIVE

James Weeks: ‘This NPR interview with Michael Greengerger is informative and really breaks down some aspects of our economy. It is also somewhat frightening. I believe you will find it interesting.’

☞ Yes. It’s very good. I’m glad I found the time.

Tomorrow, or surely some time this week, finally: More of Your Thoughts on Macs, Safari, Mozy and All That