Portfolio Rebalancing
vs.
Long Term Investing

In a piece he wrote about portfolio rebalancing on the website Seeking Alpha, Joseph Shaefer of Stanford Wealth Management made some provocative comments about buy and hold investing.

Joseph Shaefer is one of my favorite stock market prognosticators and investment advisors. He writes regularly on Seeking Alpha and I find his commentary to be cogent, insightful, and accurate. He's also a terrific writer.

But I don't always agree with him and this is one such instance. And instead of making a counter argument in the comments section of the Seeking Alpha article, I thought it would have more lasting value if I presented my response here.

Excerpt from Joseph Shaefer's "Forget Buy and Hold. Periodic Rebalancing Is the New Discipline"

Warren Buffett says his favorite holding period is forever. Well, heck, that would be my favorite holding period, too! If only we could buy stocks that never went down, even in a secular bear market, of course we’d like to hold forever. It requires only one decision, then we let the miracle of compounding make us rich, right? Um, not exactly. It is seductive in its simplicity, but it doesn't really happen that way...

What is disingenuous about the comment, for most investors besides Mr. Buffett, is that the rest of us don’t have 80% of our earnings (closer to 100% lately) coming from 100% privately-held cash cows. By owning so many privately held firms, Berkshire Hathaway (BRK.A and the now much more widely available BRK.B) doesn’t have to worry when the value of their publicly-held securities plummet, as long as the private parts of the company still reel in the cash flow. And the publicly-held stocks are corporately-held -- so it doesn’t matter if it takes 10 or 50 years to come back.

But we as individuals may not have the 10 years or more it takes to get whole again. (BRK’s biggest holding, Coca-Cola (KO), was 55 in 2000 and is 54 today. Its 2nd-biggest holding, American Express (AXP), was 50 in 2000 and is 39 today. #3 Wells Fargo (WFC) was 20 ten years ago and is 28 today. Etc.) If you want to buy-and-hold, I hope you’re getting lots of dividends because even legendary investor Warren Buffett has earned just under 0% over the last ten years on his let’s-just-hold-it-forever portfolio.

Portfolio Rebalancing vs. Long Term Investing

It wasn't just telecom and tech that were overvalued. What wasn't ridiculously priced back then? Even KO was famously trading at around 60 times earnings.

In the meantime, the KO dividend increased from $.68/share in 2000 to $1.76/share today (a 150%+ increase). Now, obviously, a 150% dividend increase in a stock yielding 1.2% is hardly the poster child for dividend growth investing in high quality companies.

But then again, the fact that the yield on KO was that low was a pretty good indication in the first place that this wasn't the best place to put new money.

I could also cherry pick (and I sometimes do because the example is such a powerful illustration) by pointing out that investors who purchased McDonalds (MCD) circa 1991/1992 are now earning in excess of a 25% annual dividend yield on their original investment.

I agree with Mr. Shaefer about index funds (I'd put all my money in a CD out of spite before I ever bought an index fund). But the reality (somewhere between his example of KO in 2000 and my example of MCD in 1991/1992) is that long term ("forever") investing in the highest quality companies is not only a viable form of investing, it may very well be the definition of investing.

Disclosure: I'm a kind of hybrid value/dividend growth investor by nature who employs certain customized and conservative option trading strategies (Leveraged Investing) to regularly lower the cost basis on my long term holdings. These option strategies serve to simultaneously accelerate the dividend yield and lower the risk of my "forever" portfolio.

I honestly don't care about capital appreciation or any unrealized capital losses. Portfolio rebalancing for the sake of portfolio rebalancing is simply unnecessary.

What's important to me is that my dividend income increases every quarter and that when it comes to retirement, I won't be forced to cannibalize and draw down my life's savings.