64 - Rebalancing Kills Compounding
The DIY Investing Podcast · Trey Henninger: Private Investor, Portfolio Manager, Business Strategist, and Value Investing Expert
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Show Notes
- Modern Portfolio Theory
- Compound Interest
- Rebalancing
- Beta / Volatility
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Show OutlineThe full show notes for this episode are available at https://www.diyinvesting.org/Episode64
Modern Portfolio Theory- According to Investopedia: Modern Portfolio Theory definition
Three scenarios are compared:
- Base Case Compounding
- Diversified Portfolio
- Diversified Portfolio with Rebalancing
- If you are going to sell an investment that is up for one that is down then you should be confident that the lower cost investment actually offers a better return.
- Don't trade 10% return expectations in stocks for 2% return expectations in bonds.
- Betting on future volatility to allow you to rebalance back again is gambling not investing.
Rebalancing is an often mentioned tactic utilized in modern portfolios but seldom is it examined from first principles. The act of rebalancing can be useful to offset volatility amongst assets within similar return profiles. However, rebalancing between assets that differ in potential returns can lead to disaster. Compounding requires the ability to earn interest upon interest. If you rebalance away from the compounding asset, then you will counteract the powerful effects of compound interest.