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Volatility Underscores the Importance of Rebalancing and Tax-Loss Harvesting

By:

Head of SPDR Americas Research

  • A double-digit selloff is hard to stomach, particularly when it coincides with a global pandemic that upends society. However, it does create opportunity.
  • Right now, rebalancing and tax-loss harvesting are two topics that should be at the forefront of every portfolio construction conversation.

A double-digit selloff is hard to stomach, particularly when it coincides with a global pandemic that upends society. However, it does create an opportunity to examine best practices for portfolio construction, especially since volatility remains high, given that the S&P® 500 Index has registered the most sessions since 1933 with a plus-or-minus 1% daily return over a 30-day period.1

Rebalancing and tax-loss harvesting are two topics, therefore, that should be at the forefront of every portfolio construction conversation.

Rebalancing matters, more than ever

The timing of portfolio rebalancing can have a dramatic impact on a portfolio’s period-based and cumulative return figures. Those return differences result from “timing luck,”2 something that’s very much on display right now, as volatility has spiked and asset class dispersion has become idiosyncratically elevated.

To illustrate this point, I calculated returns for a standard 60/40 portfolio rebalanced monthly and quarterly – but with different intervals, resulting in four different quarterly periods3 – as well as the returns for a naively constructed equal-weighted sector portfolio with the same rebalancing frameworks. The chart below plots the dispersion between the five portfolios that were rebalanced differently, but similarly constructed in terms of asset mix, for March, year-to-date and over the past one-year period.

Return Dispersion Based on Rebalancing Schemes

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Footnotes

1Source Bloomberg Finance L.P., as of 04/07/2020 per Calculations by SPDR Americas Research using a rolling 30-day period. In 21 out of the last 22 trading sessions the S&P 500 Index has moved up or down by 1% as of 04/07/2020. In 1933, there were periods where it was 22 out of 22.
2“Rebalance Timing Luck: The Difference between Hired and Fired,” Hoffstein, Sibears, Faber, Journal of Index Investing January 2019.
3January- April- July- October; February- May- August- November; March- June- September- December.
4Based on S&P 500 sector returns from 1991-2019 based on data from Bloomberg Finance L.P. Calculations per SPDR Americas Research.
5Tax Alpha = Excess After-Tax Return – Excess Pre-Tax Return.
6Last In, First Out (LIFO) Definition: An accounting method for inventory and cost of sales in which the last items produced or purchased are assumed to be sold first; allows business owner to value inventory at the less expensive cost of the older inventory.
7Source Bloomberg Finance L.P., as of 04/07/2020 per Calculations by SPDR Americas Research

Glossary

Basis Point (bps)
A unit of measure forinterest rates, investment performance, pricingof investment services and other percentages in finance. One basis point is equal to onehundredth of 1 percent, or 0.01%.

Originally Posted on April 16, 2020 – Volatility Underscores the Importance of Rebalancing and Tax-Loss Harvesting

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