Using Asset Allocation to make money in a Flat Market

Sep 1, 2002 - © Kirk Lindstrom

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

The copyright of the article Using Asset Allocation to make money in a Flat Market in Investing/Personal Finance is owned by Kirk Lindstrom. 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.

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