What Now: Sell, Rebalance, or Rotate?

NOTE: In October 2020, this post, and others on the rotation strategy, will be updated, merged into a single article, and moved to my new blog at https://likelyso.com/money.

On June 1, 2019, a new method I've been analyzing recommended rotating out of stocks and into bonds, in both tax-sheltered and taxable accounts, except for low-volatility stocks. The method was developed from 100 years of historical data for US stocks, treasury bonds, and inflation; 25 years of data for international stocks, bonds, and inflation; and 25 years of indexes for minimum volatility stocks worldwide. Here's a chart that illustrates how the method would have performed since 1919 in the US. 

One line in the chart shows a portfolio invested fully and continuously in a fund that tracks the S&P 500, with dividends reinvested. Another line shows full and continuous investment in a simulated fund of 10-year US Treasuries, with interest reinvested. For comparison, another line shows a simulated fund invested 60% in the S&P 500 and 40% in 10-year Treasuries, rebalanced monthly if the percentages drift to 65-35 or 55-45. The best results, however, are for a simulated fund using one version of the new method. It is invested either 90% in the S&P 500 and 10% in 10-year Treasuries, or vice versa, using a simple decision-point at the end of each month. It requires no more effort than monthly rebalancing, but generates smaller drawdowns and bigger returns.

I'll call the new method "rotation" to distinguish it from rebalancing. In brief, rotation ...

• Does not try to pinpoint the top or bottom. In fact, it is ordinarily a bit late.
• Does not prevent drawdowns. But it greatly reduces them, by design.
• Can easily be calibrated to limit tax consequences. Monthly churn is not necessary.
• Can align with personal tolerance for risk. A 90-10 split is not the only option; others, in fact, are ordinarily better.
• Has been robust, historically, across periods of high or low inflation, trending or choppy markets, and growing, stagnant, or recessionary economies in developed countries.
• Offers guidance about when and for whom the method is advisable. Sometimes, for some individuals, rebalancing may be better.

In the weeks ahead, I'll show more examples of rotation at work in various markets, with real and simulated investment funds. And, on July 1, I'll start posting monthly results using the method, allowing you to track it in real time.