Using Asset Allocation to make money in a Flat Market

I am often asked "How do you use allocation and individual stock volatility to beat the market without using market timing?"

This is a great question!

My technique is to rebalance often rather than once a year. Using a computer I have my personal and newsletter portfolios update daily. When they change by a given percentage, I can reallocate to bring them back to my target. This has me buying stocks when they are low and selling them when they are high.

The easy way to explain it is consider an example in a flat market where you are 50% in equities and 50% in bonds. Assume neither pay interest and we are just looking at fluctuations in capital. Lets start with $100,000 with $50,000 in bonds and $50,000 in the total stock market. Lets say the market starts with VTSMX (at total US Stock Market Index Fund) at $10 goes down to $9 in Q1, goes back to $10 in Q2, continues higher to $11 in Q3 and finishes Q4 back at $10.

How would you make money following my technique?

Well, after splitting your investment 50:50 as shown in Table 1, the market goes down 10%. So now you have a total of $95,000 since only half was in the market.

Next you rebalance your assets to get back to 50:50 as shown in Table 1 for April 1 where you end up with $47,500 in both VTSMX (Equities) and Bonds.

You repeat this rebalancing every time VTSMX moves by $1.00 as shown in Table 1.


TABLE 1.
.
Quarter VTSMX Start Total Rebalanced
Price Equities Bonds Portfolio Equities Bonds 
.
Jan 1 $10 $50,000 $50,000 $100,000 
April 1 $ 9 $45,000 $50,000 $ 95,000 $47,500 $47,500 
July 1 $10 $52,778 $47,500 $100,278 $50,139 $50,139 
Oct. 1 $11 $55,153 $50,139 $105,292 $52,646 $52,646 
Jan 1 $10 $47,860 $52,646 $100,506

How about that! Your portfolio grew $506, or 0.51%, while the market completed a full cycle and ended back where it started!

The skeptics will ask "what happens if the market goes up before it does the down cycle?"

Lets see:

TABLE 2. . Quarter VTSMX Start Total Rebalanced Price Equities Bonds Portfolio Equities Bonds . Jan 1 $10 $50,000 $50,000 $100,000 April 1 $11 $55,000 $50,000 $105,000 $52,500 $52,500 July 1 $10 $47,727 $52,500 $100,278 $50,139 $50,139 Oct. 1 $ 9 $45,125 $50,139 $ 95,264 $47,632 $47,632 Jan 1 $10 $52,924 $47,632 $100,556

Go To Page: 1 2 3

The copyright of the article Using Asset Allocation to make money in a Flat Market in Investing/Personal Finance is owned by . Permission to republish Using Asset Allocation to make money in a Flat Market in print or online must be granted by the author in writing.

Print Article

Email Article

View All Articles

Here's the follow-up discussion on this article:

View all related messages

18. Nov 5, 2005 6:10 AM

Many Markets, Few Values
By JACK ABLIN

JUST BECAUSE MARKETS get out of whack -- and trust me, they always do -- doesn't mean investment portfolios must also be out of whack. In volatile time ...

-- posted by SteveT

17. May 21, 2003 7:19 AM
.
In response to message posted by capran:

Kirks issue of rebalancing makes sense if you have a well balanced portfolio to begin ...

-- posted by Kirk

16. Jan 13, 2003 3:52 PM
In response to message posted by Kirk:

I guess you could say I'm a reluctant long-term bear, not wanting to miss momentary rallies as ...

-- posted by 2win

15. Jan 13, 2003 5:45 AM
.
In response to message posted by 2win:

Nice work! Few made money last year unless they have been "stuck clock" long term bears.
...

-- posted by Kirk

14. Jan 12, 2003 9:59 PM
-- slight mistake on that 89% figure for my intermediate-term IRA performance. My records are incomplete, so that figure was way off. Actually, the gain was about 8%. ...

-- posted by 2win

For a complete listing of article comments, questions, and other discussions related to Kirk Lindstrom's Investing/Personal Finance topic, please visit the Discussions page.