How Not to Rebalance

In this article, “Rebalancing Act: Why You Shouldn’t Massage Your Portfolio Every Year” at the Wall Street Jounal Online, we are basically told to rebalance if the stocks that performed well in the previous year are not going to perform well in the upcoming year, and to NOT rebalance if the stocks that performed well in the previous year are going to do well in the upcoming year as well. Two examples are provided:

Over the five years through year-end 2004, value trounced growth. But this year, growth and value are neck-and-neck. Are growth funds on the mend? If they spurt ahead, you might hold off rebalancing, so you capture more of the recovery. Similarly, after 13 years of mostly dreadful performance, Japanese stocks started bouncing back in 2003. If you own a Japan fund, you might let your winnings run for a little longer, rather than rebalancing at year end.

This is the most ridiculous thing I have ever heard. Implementing this strategy correctly relies on having a crystal ball. And if you had a crystal ball, you wouldn’t bother with any rebalancing at all. You would just do exactly as your crystal ball told you to do. After all, a crystal ball can tell you what is going to happen in the future. It is dangerous to think that you have anything in your possession that resembles a crystal ball, or that you have any psychopathic abilities whatsoever.

Ah, but there is some sense in the article (very little), but you have to read through the entire article until you reach it:

There is, however, a risk in waiting. The further your portfolio strays from your target mix, the harder you will get hit if the market turns against you. Indeed, Richard Ferri, president of Portfolio Solutions in Troy, Mich., worries that less-frequent rebalancing is maybe too clever. “If you’re a sophisticated investor, you can look at the momentum and you might let it run a little,” he says. “But for most people, annual rebalancing works just fine. It’s ‘Happy New Year,’ I’ve got to rebalance my portfolio.” [emphasis/bold mine]