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Numerous backtests have shown that periodic rebalancing increases portfolio return, but what is the best method for rebalancing? Rebalance to equal weight? Rebalance in line with fair value growth (maybe as estimated by Morningstar) or by some proxy for fair value growth such as revenue growth? Other? Also what is the optimal starting weight of the various holdings? Thank you for your input.

rrr12345

Assume a tax deferred account.

Numerous backtests have shown that periodic rebalancing increases portfolio return...

I would be hesitant to draw that conclusion.

It depends *very* much on what's in the portfolio, how it was chosen, and what the long term prospects of those thigns are.

If you don't know much about them, then rebalancing makes some sense.
i.e., you don't have an idea about differences in their long term prospects, and you're not likely to learn that either.

But for a portfolio of hand picked equities, I would be more hesitant.
Imagine you built a portfolio of a few blue chips in 1990: Berkshire, Kodak, and GE.
Would annual rebalancing have been a good idea?
Would you at some point have had an opinion about the ongoing prospects of the underlying businesses?

The only things worth lightening up on (if such is ever worthwhile) are
* those things which are temporarily overvalued, meaning you have an idea of what they're worth, or
* those about which you have no idea about their being overvalued, so you might as well assume each price rise is a rise in multiples.

Jim

There's research quoted in several "super investor" interviews about the majority of returns in the index coming from 4% of stocks and these are the long term compounders we want to be invested in. Ive googled and can't find any research, anyone know where this comes from?

<There's research quoted in several "super investor" interviews about the majority of returns in the index coming from 4% of stocks
and these are the long term compounders we want to be invested in. Ive googled and can't find any research, anyone know where this comes from?>

Here, I think...

https://papers.ssrn.com/sol3/papers.cfm?abstract_i...

"But for a portfolio of hand picked equities, I would be more hesitant."

Thank you, Jim. You're probably right. The periodic rebalancing that works well for mechanical portfolios may not work well for a hand picked portfolio. Probably for hand picked portfolios it's better to trim or add only when holdings have become clearly overvalued or undervalued. More important than periodic trimming and adding is the choice of holdings and their weightings.

I appreciate your input.

Thanks VSG. Interesting paper. From the conclusion and "home run" stocks. Are there any further studies on stock selection and metrics identified for these that you know of. Eg Low debt, low PE and high ROIC?

Here, I think...
https://papers.ssrn.com/sol3/papers.cfm?abstract_i...


This is a study which has caused a whole lot of ink to be spread on paper.
I find it interesting as it is spectacularly misleading, yet as far as I know it is mathematically correct.
For anyone interested in the views of this old geezer on how those two are reconciled and why the study should be ignored...

http://www.datahelper.com/mi/search.phtml?nofool=y...
...which links to...
https://discussion.fool.com/t/qqqe/71784/32

Indulging in the vain sin of quoting myself:
"...that study ... held all positions for their entire lifetime'all the way through the fade and death step...
Yet we know that on any given day, most firms are not in that category at the moment.
A random selection of firms in a random finite time interval will have a strongly positive expected return,
because most picks, being chosen at random points in their lifetimes, will not be in their fade-and-die stage.
There is no need at all to be an owner of one of the few long term big winners."

Jim

<Thanks VSG. Interesting paper. From the conclusion and "home run" stocks.
Are there any further studies on stock selection and metrics identified for these that you know of. Eg Low debt, low PE and high ROIC?>

Firstly, I think Jim's correct (as usual) in advising us to take that paper with a grain of salt.
(Or maybe a pound? You can read the thread he provided to see the reasoning.)

There is the Fama & French Models. They won a Nobel, certainly worth a look...

https://en.wikipedia.org/wiki/Fama'French_three-fa...

Personally, I like buying Berkshire @1.3X book or less, or when Jim issues his occasional, official "Executive Buy Now Recommendation."
(The last time he did was last October, or thereabouts with BRK.B trading @$265 or so, Thanks Jim!)
At such a time you could also purchase some long-term puts to goose your returns, (Again props to Jim) depending on your personal need, willingness and ability to take risk.

That Is All.
Salute!

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