Starting off the new year with a few updates to clean up some loose ends. First off, new rebalancing rules - 20% relative threshold rebalancing now for all portfolios. Then, a look at my two asset changes last year: VPU supplementing VNQ and USMV taking some from PFF.
Rebalancing
In October, I wrote a review of an article on rebalancing by Michael Kitces, where my main takeaway was that portfolio rebalancing when assets deviate more than 20% (in relative terms) from their target allocations makes the most sense.
In response, I made two new versions of the RPC Income and RPC Stability portfolios to follow this approach, and left the other nine test portfolios with my simpler rebalancing rules. Those were just to use withdrawals and the occasional excess received dividends to handle rebalancing. November and December both showed better returns for the two portfolios with the new rebalancing rules compared to the original versions with only the simpler rules. Read the full rationale here:
Justin
As of January, I’ve decided to apply the 20% threshold rebalancing rules to all eleven portfolios. The better performance in November and December was part of the decision, but only a small part, since two months isn’t really enough to base anything on. There are actually two more important reasons:
First off, some of the portfolios, namely the ones with leverage, basically became unruly without threshold rebalancing. The leveraged assets within those portfolios are so volatile that they made the original asset allocations inscrutable. Take a look at the Qian portfolio, which by the end of December looked like this:
Of the eight funds, just one was less than 20% off from its ideal allocation, with three more than 50% off! The culprit behind the huge drift is the number of funds with embedded leverage: UPRO, TNA, TMF, and TYD. Those all sunk so much by the end of 2022 that they even managed to push a stable asset like VGSH to 40% away from its target.
The Levered Seasons portfolio was another example of a portfolio that had seriously strayed from the original intentions:
In this case, all the asset classes were more than 20% off, and again, three funds were more than 50% off. It was clear that the levered portfolios had gotten away from me without stricter rebalancing rules.
Starting with the December 2022 Portfolio Review (which I actually did in early January), the new rebalancing rules triggered a total rebalancing back to the original allocations in the Levered Seasons portfolio, and almost to the original allocations in the Qian portfolio. The Levered Butterfly also experienced a total rebalancing back to original allocations, as well.
I did worry if I was changing horses mid-stream when it came to my benchmark portfolios (the Classic 60/40, the Bogle Three-fund 80/20, and the 100% Equities), but these portfolios really haven’t deviated far off from the original settings, so it is a moot point with those (so far). The 60/40 would need to drift all the way to a 52/48 or a 68/32 before causing a rebalancing, and so far, the strategy to keep allocations in line solely through withdrawals has been fine.
The second main reason was that, even aside from the practical issues of a seriously out of whack portfolio, it just makes more sense to have some sort of rebalancing plan in place. Rebalancing is a wonderful opportunity to force yourself to sell high and buy low, and the more I thought about it, the more it seemed like I was being unrealistic by not taking advantage of an investment technique that I would use in real life. The rationale Kitces presents in his article just sank in to the point where it would have been foolish not to implement it where I could.
To demonstrate, take a look again at the Qian portfolio breakdown above. To bring things back in line, I wound up selling off $89,000 of VTI, VGSH, PDBC and GLDM, in order to pour money into UPRO, TNA, and TMF at prices about half what I paid for them originally. If 2023 represents good years for those three, then I’m better poised to take advantage.
VNQ vs. VPU
Back in August, I announced a change in the RPC Income portfolio that took half of the amount allocated to VNQ (Vanguard’s REIT Index ETF) and sent it to VPU (Vanguard’s Utilities sector index ETF) instead. That decision was based on my summer deep dive on REITs: as far as indexed ETFs targeting particular sectors go, the RP portfolio is probably better off with utilities instead of real estate.
Here is a brief update on how that’s going. First off, a look at the actual numbers over the past 6 months:
So, both down, but VPU down a whole lot less than VNQ. Recall that July was a pretty good month for the portfolios (the RPC Income was up 2.57%) but August and September were horror shows: -5.1% and -9.6% respectively.
Since this is only six months of data, I also did a quick backtest on Portfolio Visualizer to see what would have happened to the portfolio if I had either kept that portion all in VNQ since launch in July, 2021, or had initially chosen VPU. I also put in VTI as a benchmark to track the market (link here):
Wow, quite a different result. VPU has had lower correlation compared to VTI, along with substantially higher CAGR. The fact that it has been positive over the period is further notable.
I’m definitely feeling good about the decision to switch over, at least partially, to VPU.
USMV vs. PFF
Likewise, in October, I made a similar change in the RPC Income portfolio in regards to my allocation to PFF (iShares Preferred Shares Index ETF) after my finding that USMV was probably a better fund for RP purposes than PFF. This one started out in July 2021 as 15% in PFF, so I took half of that and bought USMV. For those scoring at home, that means that the initial 15% in VNQ and PFF turned into 7.5% each in VNQ, PFF, VPU, and USMV.
I know it’s only three months, but here are the performances of PFF and USMV since I made the switch:
Very promising for USMV over this short timeframe, but alas, I wouldn’t make too much of it.
Lengthening the backtest to July, 2021 to test how the RPC Income portfolio would be if I had either kept it all in PFF or had it originally all in USMV reveals another win for USMV. Again, VTI is included for comparison’s sake (link here):
Much better performance for USMV, but attention should be drawn to the market correlation number. At .94, that means USMV isn’t having as much of a diversifying effect on the portfolio. USMV’s standard deviation is also higher. Normally, this wouldn’t be such a concern, but the rationale for including this asset class is that it fits the role of a portfolio stabilizer and diversifier. Granted, in this case, I’d take the 11.5% extra in return, but since July 2021, USMV hasn’t exactly been a slam dunk on all accounts.
Still, just like the decision to go with VPU over VNQ, I’m feeling pretty good about USMV as opposed to PFF.