What Goes Up

Over the last 10 years, the asset class with the lowest expected return in the DFA Equity Balanced Strategy, the S&P 500 (DFA Enhanced US Large Company Fund – DFELX), had the highest performance.  At +15.6% per year, the last decade has seen large cap US stocks return over 50% more than their long-run average of about 10%!  The loser?  Emerging market value stocks.  The DFA Emerging Markets Value Fund (DFEVX) returned just +7.3% per year.

Ten years is an eternity for most investors and if the thought hasn’t crossed your mind of swinging more of your portfolio to blue-chip US stocks you wouldn’t be human.  But before you plunge into today’s asset class leader, consider that 10 years ago we saw a very different story.  Of the 11 global stock asset classes in the DFA Equity Balanced Strategy*, the S&P 500 (DFELX) had the absolute worst return, losing -2.7% per year!  Can you guess what the absolute best performer was?  Emerging markets value.  The DFA Emerging Markets Value Fund was +11.5% per year over this stretch, outperforming the S&P 500 by a whopping 14.2% per year!  Clearly, chasing yesterday’s winner can be a losing proposition.

Overall, global diversification has “hurt” for the last 10 years — the DFA Equity Balanced Strategy is up +13.6% per year, 2% annually less than the S&P 500.  But during the previous 10 years, diversifying globally across asset classes would have been a real boon.  The DFA Equity Balanced Strategy actually gained +4.4% per year compared to a loss of -2.7% annually for the S&P 500.

So if asset class performance is mostly random in the short-term, and you cannot predict when higher-expected returning asset classes like small value and emerging markets will outperform or underperform, how should this inform your portfolio decisions?  Simple — rebalance periodically back to your initial portfolio weights.

Looking back over the last two decades, if you held the DFA Equity Balanced Strategy but never rebalanced, you would have had just 10% in the S&P 500 by 2009 despite an initial weight of 20%.  Your emerging markets value allocation would have surged to 5%, almost double the initial allocation of 3%.  Being underweighted and overweighted tomorrow’s best and worst performers can be a drag on returns and increase volatility.

If instead, you rebalanced annually, you would have restored your S&P 500 and emerging markets value allocations to 20% and 3%, respectively, every year.  Not only would this have led to greater discipline and portfolio consistency, but also to higher returns.  The annually rebalanced portfolio earned +8.8% per year compared to just +8.5% for the portfolio that was never rebalanced, and just +6.1% per year for the S&P 500.  

In practice, most portfolios are rebalanced when an asset class deviates sufficiently from its initial target (say by 25%), which could reduce the amount of buying and selling without impairing returns.  This approach would have led to an identical +8.8% per year return over the last two decades, no different than annual rebalancing.

When it comes to investing, just remember that what goes up can come back down, whether we’re talking about absolute or relative returns.  By staying disciplined and sticking with your mix (rebalancing), you’re well positioned to capture returns wherever they materialize, without being unduly punished when they don’t. 

*DFA Equity Balanced Strategy = 20% S&P 500, 20% US Large Value, 10% US Microcap, 10% US Small Value, 10% REITs, 10% Int’l Value, 5% Int’l Small Cap, 5% Int’l Small Value, 3% Emerging Markets, 3% Emerging Markets Value, 4% Emerging Markets Small Cap


Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.