Ive finally rejigged my portfolio to indexing

The ideas present show a nice & easy portfolio that should do well over the long term. The thing that concerns me is the idea of portfolio balancing. your portfolio is going to have some winners (funds making higher returns than the rest of the portfolio) and some pigs (funds returning lower than the rest of your portfolio). Auto balancing effectively cuts the nuts off your winners, and feeds them to your pigs, no?

I agree ... I'm not comfortable at all with automatic portfolio rebalancing.

By auto rebalancing
The way I do it is
Not selling

When I feed more money into the fund
A higher allocation gets fed to the worst performing fund
to rebalance my original allocation targets

Its the concept of buying low
Its automated in that - if you put 30k in - that money gets distributed through all the funds - but a bit more to the lowest performing funds

Studies have been done on auto rebalancing, by selling high and buying low on a yearly basis
Outcome - no big difference

I just find it easy not having to calculate my asset allocation every time i put money in. Just feed it money and the system will keep your portfolio allocations to your original target

You set your allocation according to your risk tolerance and profile
and invest accordingly

If I let the winners ride too high such that the allocation is a lot higher than originally- then the risk profile of the portfolio changes

I actually approach "risk" from a different angle.

I only look at how much capital I have invested as my "risk" fatctor. If I put $100,000 in fund 1 returning 10%pa, and $100,000 in fund 2 returning 20%pa, at the end of 1 year, I have $110,000 in fund 1 and $120,000 in fund 2 ... yet I've only risked exactly the same amount of capital.

If fund 2 eventually gets to $200,000 ... while fund 1 drops back to $100,000 ... I consider fund 1 to be far more risky, despite being worth only half as much.

If I were then to add more money to fund 1 (being the worse performer), then I am increasing my risk factors on two accounts - not only am I exposing more of my capital to that fund than to the other, I am also exposing it to a fund which is not my best performer!

Of course this is where it gets tricky.

One one hand you might argue that many markets (and indeed shares/funds) are cyclical ... they have good periods and bad periods ... so buying in a bad period will serve you well when things pick up, and conversely, buying in a good period may see you lose when things (inevitably) turn down.

My problem with this is twofold - first, cycles are typically 7 - 10 years long ... sometimes longer, sometimes shorter. Markets which are trending down are often doing so for fundamental reasons, which will potentially take years to correct. This is opposed to short term corrections, which may equally correct back in a positive direction as markets are oversold.

The questions you need to answer: is this investment down because of short term sentiment or profit taking ? Or is it down because of a fundamental shift in the market or the end of a cycle ? Is it at the bottom and going to bounce back, or is it going to continue to fall and not show positive returns for months or years yet ?

At the same time - if I continue to back my winners ... at what point am I overexposed to market downturns ? When should one pull the plug ?

I'm not entirely sure that taking a share trading approach with funds is a reasonable way to go ... unless you hold dozens of funds, the risks and costs of moving in and out of funds is very high.

I'd be interested to hear other points of view or strategies for managing an existing fund portfolio.

One approach I'm considering is to go broad with my fund selection ... rather than adding to an existing position (beyond distribution reinvestment), to only ever make investments in new funds (allowing for multiple investments up to the same amount of capital invested in the other funds). I'm not convinced about this yet though ... I need to do a lot more thinking and testing.

One thing I'm working towards with my Compare Funds site is to develop a platform where I can begin to back-test these theories (although I consider any such testing to be fundamentally flawed given the subjective nature of fund selection and investment timing rather than the more mechanical nature of share trading). Once I've got the watchlists and portfolio tracking implemented, I should be in a position to look at building a system for tracking theoretical portfolios, which will be the first step.

Sim
I would suspect at some point once you have quite a few funds in the bag, you would start to approach the market average anyway...?
Seems a lot of work and costs just to average out a portfolio.
Why not just grab a few shares of berkshire and be done with it!

Sim
Ill try and make a thoughtful response
Dont take it as criticism

I see risk as determined by the underlying asset, its volatility or standard deviation,

I see return as primarily generated by asset allocation, low fees

Ive given up trying to time a fund or share.
I realise that past performance should never figure into the equation
There are plenty of studies looking at investing in past good performers which has shown that you would be much worse off
There is the theory of momentum investing which has some credit and DFA is trying to tap this
There are also plenty of studies looking at active trading, and trying to pick highs and lows which show most underperform the index after fees

some concepts to look at
Markets Work
Diversification

dkmc: why DFA (just out of interest)? Did the FP suggest them or had you researched them particularly? What sets them apart from other fund managers in your opinion? Thanks!

All my research is done independent of a FA
After I did my research I went out researching the best way to access them, and researched advisors

DFA - are an index - but the only indexes to show a value, and small company tilt.
On the academic side of things its been shown that value and small company tilts will both increase returns
DFA only deal with large investors 1million and above, and have the advantage of doing block trading
It also means they dont have investors buying and selling - creating capital gains - so they are tax efficient
The directors - are the most qualified of any company - they have 2 nobel prize winners in finance or economics - they follow their research and are at the cutting edge.

Im sounding like im just trying to sell DFA. But do your own research on what evidence is there that drives returns
Ie ask yourself - how are you picking funds
we know past performance is a bad way to pick funds
we know picking the management works a bit - but then they get head hunted to other management companies
We know 80-90% of active investors do worse than the index
Theres strong evidence that you can increase the returns of an index by tilting toward small growth and value.
But you must do it in the context of a whole portfolio

When you pick funds - ask yourself what are you basing this on
And run through all the logic, take away the emotion

Compare the track record of funds against DFA value and small - exclude geared funds as you can gear into dfa - and Id have trouble finding any funds beating it. I did this prospectively and watched it for 4yrs - I wasnt looking at past performance but setup a watchlist of funds 3-4yrs ago.

There is no other index tilted toward value as measured by the book to market ratio and small growth in australia
In the US vanguard do it a bit


If you have a strategy that can beat the after tax index returns by several %
with low volatility please let me know
Tell me about the evidence behind it, whether its been validated over different time periods and different countries.

Also why do you think you can beat professional managers with access to better information, who work on this all day? Most of those guys do worse than the index too. Yes there is the occasional winner who is either lucky, happened to land on one end of the bell curve, or actually has skill - very rare.

Im still reading and learning

readings
A good start is
Presentations page

The podcasts on Index Funds | DFA Funds Approved Advisor - Dimensional Fund Advisors Approved

The following books - in particular read the comments
Amazon.com: The Bogleheads' Guide to Investing:...
Amazon.com: Index Funds: The 12-Step Program for...
Amazon.com: All About Asset Allocation: Books:... Shows how to improve return and reduce risk with asset allocation

another forum
Guide to the Vanguard Diehards Forums
though I think it is too US centred to be of any use to us though

DFA Funds: The Porsche of Index Funds » My Money Blog


Once you understand it all its such a big relief that you can invest large sums of money, with the confidence of a passive strategy, that you have done all the research behind it and there are not a lot of decisions to be made
You dont have to decide when to buy and sell stocks - you dont have regret of having sold too early or bought too late


dkmc

I dont want to repeat previous mistakes

I previously chose funds that were sexy - without the entry fee
ie at various times
colonial first state imputation, future leaders
bt imputation
platinum asia
platinum brands
various stocks that Id tried to pick
tech stocks - at a time where I thought you couldnt go wrong before the tech bust
-- its a bit like china and resources now - you emotionally feel that it is a sure thing, and invest a large amount of your portfolio in this area
However over time you learn you cant really time very well
you are taking on higher risk, higher volatility
You buy and sell a lot more and generate taxable gains or losses

Youd do worse with the above approach than the index approach im suggesting
This is from my experience. I hope some of you can take this on earlier so that you dont repeat my mistakes

Things become so much clearer, easier, and you can focus your time on better things in life