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ElLobo
Participant ○○

Ratchet rebalance

Once you have set your asset allocation, rebalancing, whether you do it or not, quite simply brings your portfolio back to it whenever one of your asset classes appreciates more than the other (typically the more volatile stock allocation) or depreciates more.  It doesn't even have to mean your stock/bond allocation.  It could be, for example, your domestic/foreign allocation, or your growth/income allocation, given that two funds are involved.

You typically set a time to rebalance (yearly, quarterly, monthly) or a rebalancing band (maybe 5% or 10% drift away from your target.)  Whether or not rebalancing leads to higher portfolio returns and/or lower risks and/or higher/lower risk adjusted returns is subject to endless mass debate, but isn't part of THIS thread.

Consider a growth/income portfolio consisting of two funds, one growth, say VIGAX, and one income, say VWEHX.  Or one balanced, say VWELX, one income, maybehaps VWEHX again.  Whenever the objective of the portfolio is the income thrown off, not its growth, like in retirement, it makes sense to do a ratchet rebalance, where you only rebalance in one direction, whenever the portfolio income increases as a result.  That is, you only rebalance from the lower yielding fund to the higher yielding one.

It even makes sense for the traditional stock/bond market index fund portfolio.  VTSMX yields 1.67% while VBMFX yields 2,64%.  If your allocation is 60/40, you are receiving $205.80 per year for each $10,000 value of your portfolio.  At the end of the year, say your allocation 'drift' got to 64/36 with the run up in stock prices.  You would still receive $205.80, but if you rebalance back to 60/40, your total portfolio income would go up next year.

A 64/36 allocation would reflect a $1000 appreciation in stock prices (VTSMX) with bond prices stagnant, since $7000/$11,000 is 64% stocks.  That extra $1,000 would throw off $14.30 next year, by staying in VTSMX, since the VTSMX yield goes down to 1.43% whenever the NAV went up 17% ($7000/$6000).  Moving that $1000 to VBMFX would increase that to $26.40, since it would then earn the 2.64% VBMFX distribution.

However, if VBMFX appreciated the same $1,000, with VTSMX stagnant, OR VTSMX dropped $1000 in value, you wouldn't rebalance, since next year's income would be reduced by the same amount (down from $26.40 to $16.70.  Ratcheting rebalance takes capital gains off the table and converts them to income.  An income focused investor isn't interested in going both ways!

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33 Replies
steelpony10
Participant ○○

Re: Ratchet rebalance

       El - your posts always make my head hurt. Coffee drinker? I personally, being odd poster out, only rebalance risk when I need to following a long term plan. Currently we’re slowly cutting down on single growth stocks and putting the proceeds into VUG. In my aging mind this allows us to purchase more 7-9% CEF income in a TIRA. 

        We’ve never allocated or really rebalanced just took capital gains when an obvious disconnect occurred like in 2017 between price and earnings rate. For example a stock with recent EPS rate of 6% going up 20% and we then waited for the next stock sale when the opposite occurred seeking more income. Big bets on MSFT, AAPL, INTC  and AMZN, momentum stocks at the time, required another technique. 

         Anyway long term we’re aiming for an all CEF retirement portfolio of the best managed at the best cost when needed without regard to investment classification or any allocation. The timing of this is random and on our personal terms. 

          

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ElLobo
Participant ○○

Re: Ratchet rebalance


@steelpony10 wrote:

       El - your posts always make my head hurt. Coffee drinker? I personally, being odd poster out, only rebalance risk when I need to following a long term plan. Currently we’re slowly cutting down on single growth stocks and putting the proceeds into VUG. In my aging mind this allows us to purchase more 7-9% CEF income in a TIRA. 

        We’ve never allocated or really rebalanced just took capital gains when an obvious disconnect occurred like in 2017 between price and earnings rate. For example a stock with recent EPS rate of 6% going up 20% and we then waited for the next stock sale when the opposite occurred seeking more income. Big bets on MSFT, AAPL, INTC  and AMZN, momentum stocks at the time required another technique. 

         Anyway long term we’re aiming for an all CEF retirement portfolio of the best managed at the best cost when needed without regard to investment classification or any allocation. The timing of this is random and on our personal terms. 

          


Sounds like you've been doing ratcheting rebalance most of your life, as I have been doing!  Lots of investors, as they approach retirement, talk about asset allocation during retirement and may, or may not, rebalance!  Anyhow, I made this post simply because I haven't seen rebalancing discussed in any recent thread.  8-))

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yogibearbull
Valued Contributor

Re: Ratchet rebalance

This seems a variation of traditional rebalancing. 

That is, rebalance when equities become overweighted, but not when they become underweighted.

Income angle aside, it defeats one of the purposes of rebalancing, IMO. One may have a buffer account with 2-3 years of withdrawal requirements [or for supplementing withdrawals] and let portfolio rebalance normally.

YBB
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ElLobo
Participant ○○

Re: Ratchet rebalance


@yogibearbull wrote:

This seems a variation of traditional rebalancing. 

That is, rebalance when equities become overweighted, but not when they become underweighted.

Income angle aside, it defeats one of the purposes of rebalancing, IMO. One may have a buffer account with 2-3 years of withdrawal requirements [or for supplementing withdrawals] and let portfolio rebalance normally.


As I said, traditional rebalancing is moving cash in both directions, just to maintain some arbitrary asset allocation.  Indeed, the traditional retirement withdrawal studies all assume yearly rebalancing in that regard.  Ratcheting simply does it for non-arbitrary reasons!

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steelpony10
Participant ○○

Re: Ratchet rebalance

      El - So ok a random “rebalancing” in the broadest of terms although I never thought of allocations or diversification just risk and reward. That’s what investing means to me not safety.

       My whole attitude stems from a mentor that stated “Why invest to try to balance an unknown risk when your net gain could be zero or you lose”. Sorta futile with a chance of a lousy result. 

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ElLobo
Participant ○○

Re: Ratchet rebalance


@steelpony10 wrote:

      El - So ok a random “rebalancing” in the broadest of terms although I never thought of allocations or diversification just risk and reward. That’s what investing means to me not safety.

       My whole attitude stems from a mentor that stated “Why invest to try to balance an unknown risk when your net gain could be zero or you lose”. Sorta futile with a chance of a lousy result. 


These days, it's all one and the same.  You 'allocate' 60/40 because you believe that allocation matches the return you EXpect with the risks that you ACcept.  Someone else, at 50/50, has a lower expected return with appropriate lower risk.  And so forth.

I seriously doubt that anyone around here who 'allocates' in this way knows and understands all of the underlying details of what that actually means!  How risk and returns are interelated, how some risks, such as that of running out of nestegg during retirement, is related to, even the same as, the SD risk for a portfolio, let alone each of the two funds within it.  Stuff like Modern Portfolio Theory (MPT), Capital Asset Pricing Model (CAPM), Efficient Markets/Frontiers/Surfaces, Mean Variance Optimization (MVO), Fama French 3/5 Factor (FF3/5F) and on and on!

Anyhow, this isn't some deep thinking, finely detailed analysis, as you wanted to make it.  It was more tuned to those around here who 'allocate' 60/40, or 50/50, or 100/0 for reasons that someone once said was 'appropriate'!  Like general rules of thumb that, as you approach retirement, your bond allocation should match your age!  8-))

(Maybehaps I shoulda posted this on Bogleheads, not I&D!)

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bilperk
Participant ○○○

Re: Ratchet rebalance


@ElLobo wrote:

@yogibearbull wrote:

This seems a variation of traditional rebalancing. 

That is, rebalance when equities become overweighted, but not when they become underweighted.

Income angle aside, it defeats one of the purposes of rebalancing, IMO. One may have a buffer account with 2-3 years of withdrawal requirements [or for supplementing withdrawals] and let portfolio rebalance normally.


As I said, traditional rebalancing is moving cash in both directions, just to maintain some arbitrary asset allocation.  Indeed, the traditional retirement withdrawal studies all assume yearly rebalancing in that regard.  Ratcheting simply does it for non-arbitrary reasons!


If income is your only goal, your example seems to be a poor way of achieving it.  Why have a "growth" component at all?  Why not use VYM and VWEHX, or any other higher income producers?

 

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ElLobo
Participant ○○

Re: Ratchet rebalance


@bilperk wrote:

@ElLobo wrote:

@yogibearbull wrote:

This seems a variation of traditional rebalancing. 

That is, rebalance when equities become overweighted, but not when they become underweighted.

Income angle aside, it defeats one of the purposes of rebalancing, IMO. One may have a buffer account with 2-3 years of withdrawal requirements [or for supplementing withdrawals] and let portfolio rebalance normally.


As I said, traditional rebalancing is moving cash in both dir

ections, just to maintain some arbitrary asset allocation.  Indeed, the traditional retirement withdrawal studies all assume yearly rebalancing in that regard.  Ratcheting simply does it for non-arbitrary reasons!


If income is your only goal, your example seems to be a poor way of achieving it.  Why have a "growth" component at all?  Why not use VYM and VWEHX, or any other higher income producers?

 


You can use any two funds that you want.  Ratchet rebalance is a technique for managing a portfolio, regardless of which two funds you use.  I'm quite certain the funds that I use are different than what you would use! 8-))

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bilperk
Participant ○○○

Re: Ratchet rebalance


@ElLobo wrote:

@bilperk wrote:

@ElLobo wrote:

@yogibearbull wrote:

This seems a variation of traditional rebalancing. 

That is, rebalance when equities become overweighted, but not when they become underweighted.

Income angle aside, it defeats one of the purposes of rebalancing, IMO. One may have a buffer account with 2-3 years of withdrawal requirements [or for supplementing withdrawals] and let portfolio rebalance normally.


As I said, traditional rebalancing is moving cash in both dir

ections, just to maintain some arbitrary asset allocation.  Indeed, the traditional retirement withdrawal studies all assume yearly rebalancing in that regard.  Ratcheting simply does it for non-arbitrary reasons!


If income is your only goal, your example seems to be a poor way of achieving it.  Why have a "growth" component at all?  Why not use VYM and VWEHX, or any other higher income producers?

 


You can use any two funds that you want.  Ratchet rebalance is a technique for managing a portfolio, regardless of which two funds you use.  I'm quite certain the funds that I use are different than what you would use! 8-))


Yup.  I use Wellesley and it auto rebalances.  The good news is both the bond coupons and the stock dividends are around 3% so no worries about ratcheting.

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steelpony10
Participant ○○

Re: Ratchet rebalance

    Well in that case El any reasonably sized and fairly well managed retirement portfolio allocated that way should be fine for 15-20 years. Although I would expect a bear market of some sort in that time period. As far as a retirees personal requirements during that time or longer that’s still an unknown. I still believe some retirees (posters) will seize up in a bear market negating something like a 4% rule and will continue to try to market time a successful outcome based on what they think.

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Saltydog
Explorer ○

Re: Ratchet rebalance

Are we making rebalancing too complex? I have always set wide bands, e.g. Stocks 60-70% (Mine are even wider) and looked at them no earlier than annually. With wide bands and occasional additions to bonds, I have only rebalanced once and that was during a raging bull market. I sold off concentrations with the highest p/e ratios, one of which was General Electric with a p/e of 55. Dumb luck can be a strategy. Why run up capital gains taxes and trading costs?

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ElLobo
Participant ○○

Re: Ratchet rebalance

"Yup. I use Wellesley and it auto rebalances. The good news is both the bond coupons and the stock dividends are around 3% so no worries about ratcheting."

What about 50/50 VWELX/VWEHX, with yearly ratcheting rebalance, taking all distributions as cash?  WELEX yields 2.42%, VWEHX yields 5.45%.  At no time over the last two decades did the cash distribution fall below $450 (4.5%), for $10,000 invested 20 years ago.  Link

In fact, ifn you look at that ratcheting combo back to the limit of Portfolio Visualizer (1985), it supported an 8% rate of retirement withdrawal without touching principle.  Don't know ifn it would have supported a real inflation adjusted 8% however!  link

Putting both into the Portfolio Optimization tool at PV shows that the most efficient allocation to be 55/45 VWELX/VWEHX, not far at all from 50/50.  It shows that the Safe Withdrawal rate for both, since 1985, was 8.6%!  Look in the metrics tab.   link

Over those 35 years, ratcheting provided more income than an all VWELX portfolio during the early years, while in the later years, ratcheting provided more income than an all VWEHX portfolio, given that its distribution has continuously fallen over the years while those of VWELX have risen (stock diveys).

Yup, this is a lookback.  It just shows to go you how ratcheting, once a year, affected the portfolio cash flow with all distributions taken as cash!  8-))

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ElLobo
Participant ○○

Re: Ratchet rebalance


@steelpony10 wrote:

    Well in that case El any reasonably sized and fairly well managed retirement portfolio allocated that way should be fine for 15-20 years. Although I would expect a bear market of some sort in that time period. As far as a retirees personal requirements during that time or longer that’s still an unknown. I still believe some retirees (posters) will seize up in a bear market negating something like a 4% rule and will continue to try to market time a successful outcome based on what they think.


It's just a tactic that some might use, most probably won't.  Probably more useful for those in retirement who use simple two fund portfolios, probably both indexed, and who employ 'buckets' to handle Sequence of Return risks and multi year negative returns in the stock market!

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ElLobo
Participant ○○

Re: Ratchet rebalance

@bilperk 

In a moment of reflection today, as I drafted the OP, I was thinking of VWELX and VWEHX and my efforts many moons ago to come up with my 'withdrawal and spend only the income from my retirement portfolio, reinvesting any excess yield as seed corn to compensate for falling distribution and inflation' strategy.  As you may recall, I figured that relying on the income was better than relying on fund NAV appreciation!  And on and on.  Of all the Vanguard funds, VWEHX best fit the bill, back in the late 90's.

But that was before the tools we have today, like PV.  I remember, getting the complete monthly distribution history for VWEHX, along with the fund NAV on the day of distribution.  Constructed spreadsheets of monthly NAVs and distributions, 'counted shares' while taking various amounts of cash out for withdrawals.  Pretty heavy stuff, without today's tools.

My reflection is that I never thought to look at any other funds, like VWELX, given the effort to do the work.  Had PV been around back then, I would have gone 50/50 VWELX/VWEHX and ratcheted as I described in this thread!  Here is the link, from 1985 to 2003, the year of my retirement: link

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bilperk
Participant ○○○

Re: Ratchet rebalance


@ElLobo wrote:

"Yup. I use Wellesley and it auto rebalances. The good news is both the bond coupons and the stock dividends are around 3% so no worries about ratcheting."

What about 50/50 VWELX/VWEHX, with yearly ratcheting rebalance, taking all distributions as cash?  WELEX yields 2.42%, VWEHX yields 5.45%.  At no time over the last two decades did the cash distribution fall below $450 (4.5%), for $10,000 invested 20 years ago.  Link

In fact, ifn you look at that ratcheting combo back to the limit of Portfolio Visualizer (1985), it supported an 8% rate of retirement withdrawal without touching principle.  Don't know ifn it would have supported a real inflation adjusted 8% however!  link

Putting both into the Portfolio Optimization tool at PV shows that the most efficient allocation to be 55/45 VWELX/VWEHX, not far at all from 50/50.  It shows that the Safe Withdrawal rate for both, since 1985, was 8.6%!  Look in the metrics tab.   link

Over those 35 years, ratcheting provided more income than an all VWELX portfolio during the early years, while in the later years, ratcheting provided more income than an all VWEHX portfolio, given that its distribution has continuously fallen over the years while those of VWELX have risen (stock diveys).

Yup, this is a lookback.  It just shows to go you how ratcheting, once a year, affected the portfolio cash flow with all distributions taken as cash!  8-))


Some questions:

How much total income did the W/HY portfolio produce from 1985-2019?
How much income would VWEHX alone have produced?
Why does it appear that Wellington produced far more income by itself than the W/HY combo?
How much income did Wellington produce?

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PatMorgan
Explorer ○

Re: Ratchet rebalance


@ElLobo wrote:

What about 50/50 VWELX/VWEHX, with yearly ratcheting rebalance, taking all distributions as cash?  WELEX yields 2.42%, VWEHX yields 5.45%.  At no time over the last two decades did the cash distribution fall below $450 (4.5%), for $10,000 invested 20 years ago.  Link


Let's look at how yearly ratchet rebalancing using VWELX and VWEHX, taking income distributions in cash, would have done over the full calendar years that both funds have existed. Here is a chart of the inflation-adjusted yearly income distribution amounts of 1) VWELX and 2) ratchet rebalanced 50/50 VWELX/VWEHX, with both investment options starting with a $10,000 balance at the end of 1978.ratchetRebal-VWEHX-VWELX.svgThe income from VWELX generally kept up with inflation, with some ups and downs. The income from ratchet rebalancing with VWEHX generally declined over time. The average inflation-adjusted income was 38% higher for VWELX alone. Using VWELX alone has definitely been the better choice than ratchet rebalancing with VEWHX.

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ElLobo
Participant ○○

Re: Ratchet rebalance

Pat, can you add the VWEHX data to your chart please?  Also, did you ratchet rebalance or did you simply do a regular normal rebalance each year (as I did, using PV)?

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ElLobo
Participant ○○

Re: Ratchet rebalance

How much total income did the W/HY portfolio produce from 1985-2019?
How much income would VWEHX alone have produced?
How much income did Wellington produce?

Why does it appear that Wellington produced far more income by itself than the W/HY combo?

I don't have the numbers.  Hopefully, Pat can shed light.

There is no question that, from 1978 to about 1988, 10 years, VWEHX produced more income that VWELX.  The initial yield of VWEHX was, as I recall, about 12%, with a first year distribution of $1.20 and an initial NAV of $10.  I don't know what the VWELX yield was back then, in 1978, since Yahoo! doesn't go back that far.  Anyhow, for 1980, VWEHX distributed $1.20 while VWELX distributed 75 cents.  Since the VWELX NAV in early January 1980 was $9.00 while VWEHX was about $9.50, $10,000 invested in each meant that VWELX distributed $833 while VWEHX distributed $1,263.

Then, from 1988 to about 1995, it was a tossup, from one year to the next.  Unquestioningly, since then, VWELX has far outperformed (distributed more cash), given that the VWEHX distribution has declined continuously over time while that of VWELX has increased.

I conclude that, from 1978 to 1995, the 50/50 VWEHX combo produced more than the all VWELX portfolio and less than an all VWEHX portfolio.  Since then, visa versa.

I also want to point out that I used Portfolio Visualizer and it doesn't do a ratchet rebalance, only the normal, regular one once a year.  Whenever I re-ran, turning rebalancing off, it didn't seem to make much of a difference.  VWELX is about 60/40, so any comparison of which fund, or combo, performed better that the other is really a comparison between all VWELX, at 60/40 allocation, 30/70 (for a 50/50 VWELX/VWEHX portfolio), or 0/100 where, with distributions taken as cash and not compounding, resulted in an ever decreasing total portfolio cash flow!  8-))

Anyhow, I just thought this example, using two funds which you  and I  both know fairly well, was interesting.  But what about going forward?  I would expect $10,000 that a newbie would invest in each fund, or a combo, would produce $242 for all Wellington, $545 for all high yield, and $393.50 for the 50/50 combo, probably able to support a 4% rate of withdrawal, going forward, without touching principle! 8-))

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bilperk
Participant ○○○

Re: Ratchet rebalance

I wonder if PV, when you use " do not reinvest dividends", does reinvest Capital gains distributions.  Wellington has gotten a ton of those over the years so would have built a lot more shares, thus increasing income, while VWEHX had very few over its history.

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