“Maybe it’s time for world-stock funds, rather than ones that focus separately on the U.S. and overseas,” advises a story in The Wall Street Journal. It’s a good idea—up to a point. The strategy of using core funds, perhaps even a super core for the entire asset allocation process, has merit. But there’s a danger of going too far. The problem is that if you put too much in a core fund, rebalancing opportunities are limited if not short-circuited completely, depending on the core fund you hold and how much it represents of your allocation in that asset class.

There are valid concerns about how to divide, say, an equity allocation. One common strategy for stocks for U.S.-based investors is defining the world markets by domestic, foreign-developed and emerging-market equities. Sophisticated investors may prefer more granular slicing and dicing via sectors or countries, or perhaps dividing regions into pieces.
By contrast, you can now find ETFs and actively managed funds that cover the world in one ticker. Two examples: Vanguard Total World Stock (VT) and iShares MSCI ACWI (ACWI). These broadly defined equity funds serve a useful role for establishing a core allocation. But putting the entire stock allocation into such portfolios effectively ties your hands when it comes to rebalancing.
Let’s say that 100% of your equity allocation is in Vanguard Total World Stock, which is a cap-weighted ETF. In that case, the rebalancing process is fully run by the market/fund. By contrast, holding an equivalent portfolio in, say, three pieces—U.S., foreign developed and emerging markets—leaves you in control of rebalancing for deciding when and how to adjust the relative weights.
Why is rebalancing important? It may not be—if you have a very long-term time horizon. But for most folks (and even most institutions) it’s hard to think (much less act) in 30-year slices. The short-term, in other words, matters. That’s where rebalancing comes in. It’s unclear what constitutes optimal rebalancing strategies. But for broadly diversified portfolios, there’s persuasive empirical evidence that basic rebalancing rules are productive for boosting return, lowering risk, and perhaps a bit of both. That’s been true within asset classes and for asset allocation strategies as well.
Rebalancing is essentially a system for exploiting volatility. The strategy comes in a variety of flavors, but simple, forecast-free rules can be quite effective for broad asset allocation strategies, as I discussed last month. At the same time, holding core positions can help anchor asset allocation strategies by providing a foundation. As with most investing strategies, finding a prudent balance between extremes works best for most of us. Without full clarity about what’s coming, it’s often a good idea to apply some hedging vs. embracing the radical outer limits of portfolio possibilities.
For instance, it’s reasonable to hold Vanguard Total World Stock as, say, 50% of an equity allocation and put the other half of the allocation into various funds that target specific pieces of the global stock market. In that case, the core holding might be left alone, other than to buy or sell to keep it at a roughly 50% weighting. Meantime, the rebalancing activity would be pursued with the remaining funds that represent components of global equities. A similar strategy can also be applied to the other asset classes.
This much is clear: If you hold one broadly defined fund to represent an asset class, you’re betting that rebalancing won’t be productive in the years ahead. Anything’s possible in finance because the future’s always uncertain. But history strongly suggests we should be cautious in expecting rebalancing to be worthless from here on out.