Is the buy-and-hold portfolio strategy dead? Morningstar has been discussing the question lately, and the answer is that, well, it’s complicated.

Let’s be clear about one thing: Very few investors are true buy-and-holders for the long run, nor should they be. Leaving a portfolio completely untended over years if not decades is simply abandoning the responsibilities of investing. That doesn’t mean you should trade frequently. But ignoring an investment strategy isn’t practical.
The idea of the “coffee can” portfolio, an idea espoused by Bob Kirby way back in 1984, has a certain appeal: Buy assets, sock ’em away, and forget about ’em for long, long periods of time. There’s wisdom in the idea, in part because buy and hold cuts down on trading costs, taxes, and the anxiety of worrying about the short-term market noise. But financial economics has taught us much since 1984, and so the idea of literally buying and holding doesn’t pass the smell test.
The problem is that assets can suffer lengthy periods of loss. U.S. stocks, to cite the obvious victim, have lost about 1.3% a year, based on the Russell 3000’s annualized history over the past 10 years. Sounds pretty bad and it is. But a few thoughts.
First, if you look at the rolling annualized 10-year periods for U.S. stocks since 1926 (courtesy of Ibbotson Associates) you find that losses over a decade are quite rare. The fact that we just had one of those rare periods has many pundits crying foul and recommending that you avoid or substantially underweight equities from here on out. But where was that advice when you needed it?
A decade ago, the prevailing wisdom favored overweighting stocks. Certainly the case for equities looked compelling in early 2000, before the first stock market crash of the 21st century. Now, with stocks limping along and suffering one of their worst 10-year periods in history, the argument to avoid stocks is riding high. Maybe that’s good advice, but it’s worth thinking twice before beating the farm on expecting stocks to deliver another unusual loss over the decade ahead. Here’s one forecast you can count on: If stocks do well over, say, the next five years, there’ll be a surfeit of strategists telling you to overweight stocks.
But a careful reading of the research literature reminds that equities are volatile and they go in and out of favor. Risk premia have a tendency to mean revert, in other words. That’s not surprising, although it can be a problem if you own a relatively small sampling of securities or asset classes.
Remember that stocks—domestic stocks in particular—are just one corner of the broad asset class pie. One of the smartest things investors can do is also one of the easiest: own a bunch of different asset classes. The broad categories are stocks, bonds, commodities and REITs. We can and probably should slice and dice each of those groups into subcategories, particularly with stocks and bonds, starting with the domestic/international distinction. Indeed, bonds now come in a variety of flavors that every investor should exploit on a cross-border basis, including governments, credits, nominal and inflation-indexed varieties.
Why focus on carving up the major asset classes into finer pieces? In a word, rebalancing. Asset allocation is a powerful tool for diversifying risk. But combining asset allocation with rebalancing creates an even stronger strategy. And by rebalancing I’m talking of resetting the portfolio mix back to its target weights. In that sense, rebalancing requires no forecasting skill. Tactical asset allocation, by contrast, is based on looking ahead, and so that’s a separate issue.
As for rebalancing, a number of studies over the years show that preventing asset allocation target weights from moving too far afield can modestly enhance return, reduce risk, or both. For example, a recent edition of Burton Malkiel’s best seller A Random Walk Down Wall Street shows that annually rebalancing a 60/40 stock/bond mix boosts return by around 40 basis points while reducing volatility.
In Dynamic Asset Allocation, I review some of the research over the years that focuses on rebalancing. A number of studies show that a simple rebalancing strategy can boost return by 50 to 100 basis points over the long haul, assuming a multi-asset class portfolio.
Is this guaranteed? No, of course not, and neither is anything else in finance. Much depends on the period of time. If you rebalanced a stock/bond portfolio in the late-1990s, you would have reduced performance vs. simply leaving the asset allocation alone. Of course, rebalancing helped if you measure the results through 2000 and beyond, which includes a sharp drop in equities.
For another perspective, consider how a passive mix of all the major asset classes fared over the past 10 years in an unmanaged cap-weighted form and an annually rebalanced version. In my newsletter, The Beta Investment Report, I routinely analyze the Global Market Index and its main components for subscribers. One area of focus is monitoring the unmanaged and rebalanced versions of GMI. For the decade through last month, the straight GMI generated a 3.4% annualized total return. That’s quite a bit better than the -1.3% for U.S. stocks (Russell 3000).
The message here: asset allocation can help, or at least it did over the past decade. Why did it help? Because other asset classes did quite well over the past 10 years even though stocks fared poorly. A few examples include the 6.5% annualized total return for investment grade bonds (Barclays Aggregate) since 2000; 10.2% for REITs (FTSE NAREIT); 4.4% for commodities (DJ-UBS Commodity); and 11.2% a year for emerging market bonds (Citi ESBI-Capped).
No wonder that GMI, which owns everything, delivered 3.4% a year. And if you simply rebalanced GMI back to earlier weights every December 31, that 3.4% rises slightly to a 4.4% annualized total return. Asset allocation and rebalancing are powerful tools, particularly when they’re used in concert.
So, what are the caveats? Again, expecting rebalancing and/or even asset allocation to always boost return in every period is asking for trouble. It might not, depending on what’s going on with the markets. Indeed, some financial advisors argue that asset allocation and rebalancing are first and foremost tools for managing risk. As such, these fundamental components of portfolio management are considered by some as guardrails that keep investors from going into the ditch.
There’s also the challenge of deciding when to rebalance. Doing so on different dates can deliver different results. But this is less of a problem than it seems if you rebalance over long periods of time, which tends to smooth over the rough edges.
Nonetheless, it pays to monitor the major asset classes for signals that enhance the odds of rebalancing at timely moments. For example, I recently advised subscribers that it was timely to consider rebalancing out of U.S. bonds, Treasuries in particular. That recommendation was less about forecasting and more of reviewing the strong returns for bonds vs. stocks recently. Should you exit bonds entirely? No, but if your portfolio is heavily overweighted in fixed-income vs. your target weights, the case for trimming the bond allocation and redeploying is compelling.
But let’s not forget that there are no silver bullets in portfolio management. Instead, success comes only through diligent monitoring and managing of the asset allocation. That starts by diversifying widely and planning on routine rebalancing every, say, year or two, or more frequently if you’re opportunistically inclined. Yes, there’s more, much more to do, if you’re up to the task. But the thousand-mile journey still starts with the first two steps: asset allocation and rebalancing.


  1. Lurker

    You should look at GMI with a deviation trigger for rebalancing. For example, 10 asset classes with 10% target allocation each, when the deviation of all positions from target (positive and negative, including cash) exceeds some target (say 5% or 10%), rebalance. It differs from annual rebalancing in that it’s opportunistic to cash in on big moves, but trades even less often than annually most of the time.

  2. Doug

    re-balancing frequency is also key. If you are sticking to a set schedule, doing it too often could cut your winners and invest in your losers much to early. The method that Lurker mentions would probably be the ideal in that you re-balance based on the portfolio, not the calendar.

  3. JP

    Yes, timing and magnitude are the key variables. Lots of empirical studies on what works best, what doesn’t, and how to proceed. It gets complicated real fast. It’s a fair bet, however, that if you mindlessly rebalance once every year or two, you’ll capture a healthy portion of the rebal benefits over the long haul–if you own a broad array of asset classes. Still, there are times when rebalancing is a no-brainer, even if you’re not trying to optimize the rebal process. Whenever relatively large pieces of the portfolio are posting outsized gains or losses, that’s probably a good time to rejigger the asset allocation.

Comments are closed.