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Three Studies Worth a Quick Read

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Portfolio rebalancing, dollar cost averaging, and the need for a broader approach to income investing are the focus of recent analyses done by Vanguard, J.P. Morgan and the Financial Planning Association (FPA).

Best Practices for Portfolio Rebalancing – Vanguard Research

The primary goal of a rebalancing strategy is to minimize risk relative to a target asset allocation, rather than to maximize returns.

A portfolio’s asset allocation is the major determinant of a portfolio’s risk-and-return characteristics. Yet, over time, asset classes produce different returns, so the portfolio’s asset allocation changes.

Therefore to recapture the portfolio’s original risk-and-return characteristics, the portfolio should be rebalanced.

In theory, investors select a rebalancing strategy that weighs their willingness to assume risk against expected returns net of the cost of rebalancing. Our findings indicate that there is no optimal frequency or threshold when selecting a rebalancing strategy.

Return Measures and Dollar Cost Averaging – Journal of Financial Planning

“While the debate concerning dollar cost averaging versus lump sum investing rages on, we believe the debate should center on how to accurately measure investors’ true returns,” the report explains.

Other key points in the piece:

– Understanding that ordinary people typically save for retirement via periodic contributions to a retirement account, it is imperative to correctly measure both historical and expected investor performance.

– We believe a dollar-weighted return is superior to the traditional simple averages typically employed.

– During the period 1990 —2009 an all equity fund earned a geometric average return of 8.21 percent while the realized dollar-weighted annual return earned by an investor making annual contributions to an all equity fund was only 6.41 percent due to the pattern of returns over the period. Our simulations suggest that such an extreme difference has a small probability of occurring.

– We show there is a decrease in ending wealth variability for a more balanced approach to investing. This implies that even young investors might consider a balanced asset allocation to reduce the likelihood of such a divergent outcome.

Investment Insights: The Case for a Broader Approach to Income Investing - J.P. Morgan

With interest rates now at extremely low levels and government debt ballooning, it is becoming increasingly difficult to generate a satisfactory stream of income without taking on more risk. In this environment, investors may want to explore a broader approach to income investing.

– Current low interest rates on Treasuries can make traditional fixed income sectors look both risky and unrewarding.

– A broad strategy for building income-producing portfolios could include assets, such as dividend-paying stocks, which can provide a cushion if the market remains volatile, as well as an attractive tax advantage over taxable fixed income, given the probable tax increases on the horizon.

– International investments should also be part of an income solution, giving investors diversification benefits and access to a global economy that will likely continue to outperform that of the U.S., while providing attractive dividend yields, as well as the opportunity to benefit from a potentially declining dollar.