Home Adviser Fund Update Meaning Behind Vanguard Fund Name Changes Published January 27, 2017 Name Changes for Vanguard Money Market Funds Vanguard is changing the names of five of its tax-exempt money market funds in the first quarter of 2017, replacing “Tax-Exempt” with “Municipal” to expand each fund’s investment universe. Ticker Previous Name New Name VMSXX Tax-Exempt Money Market Municipal Money Market VCTXX California Tax-Exempt Money Market California Municipal Money Market VNJXX New Jersey Tax-Exempt Money Market New Jersey Municipal Money Market VYFXX New York Tax-Exempt Money Market New York Municipal Money Market VPTXX Pennsylvania Tax-Exempt Money Market Pennsylvania Municipal Money Market Source: The Vanguard Group. The name changes will coincide with the release of each funds’ annual prospectus update. Tax-Exempt Money Market will be renamed Municipal Money Market on or about February 24, 2017, while the state funds’ names will change on or about March 28, 2017. (Note that Ohio Tax-Exempt Money Market is not included on this list because it is scheduled to be liquidated on February 22.) The moves are intended to add cash management flexibility to the funds’ management. Since each tax-exempt money market fund is required by its investment policy to put 80% of assets in securities described by its name, swapping “tax-exempt” for “municipal” enlarges the investment pools. In particular, it frees up the ability to invest in the taxable corner of the municipal market. Vanguard asserts that the funds’ investment objectives—which specifically state a goal of delivering income exempt from federal and state (for the state-specific funds) taxes—won’t change as a result of the new names. Note that the funds’ mandates do include the ability to invest up to 20% of assets in securities subject to the Alternative Minimum Tax, however. We would guess that most investors will not notice any significant changes in the performance or composition of the funds following the renaming. Does Portfolio Rebalancing Work? Every year around this time, you’ll see media attention on the questions of when, why and how you should rebalance your portfolio. Despite all of the air time and column inches devoted to the subject and nudges from fund companies, the conclusions are often the same—sell your winners and buy your losers at least annually, if not every quarter. This discussion is particularly relevant after the strong run for U.S. stocksA financial instrument giving the holder a proportion of the ownership and earnings of a company. compared to nearly every other asset class in 2016 that pushed many portfolios away from their initial allocations. Looking at the data, there’s ample reason to question if rebalancing that often—or even at all—is necessary, even during times of increased market volatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in.. Advocates for rebalancing argue that the strategy is all about riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. control—that maintaining a target allocation between stocks, bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. and other asset classes can effectively manage the overall risk in your portfolio across market cycles. As an example, say you start out with a simple 50%–50% mix of stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. and bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. funds in a portfolio. After a period when stocks outperform, it may become skewed to a 60%–40% or 70%–30% mix, leaving you at increased risk of losing those gains if stocks drop. The overarching theory behind rebalancing: Keep allocations in check, thus reducing risk. On the face of it, sure, that’s good advice. Fidelity and Vanguard have periodically addressed rebalancing over the years, with the firms recommending to rebalance either on a semiannual or annual basis, or when allocations drift more than 5% or 10% away from their targets. Those conclusions seemed a bit simplistic to us, but before making any judgments, we wanted to run a few numbers ourselves. We constructed a hypothetical portfolio of index funds with a 50%–50% split between stocks (Vanguard 500 Index) and bonds (Vanguard Total BondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. Market Index) and tracked the results of several rebalancing scenarios from January 1987 (just after Total Bond Market’s inception) through December 2016. In the first scenario, we rebalanced the portfolio every six months, in January and July. In the second test, we rebalanced once a year in January, and in the third, we rebalanced every third January. (We used January because it’s best to rebalance after December distributions and the tax-year has turned.) When we examined rolling returns for each scenario, analyzing average returns as well as the best and worst returns for one-month, one-year, three-year and five-year periods, our findings were pretty conclusive: The less frequently you rebalance, the greater the return potential and greater the volatility over any given period. When we’ve run this analysis in the past, over shorter periods, some of the rebalancing strategies posted slightly better returns, but after a strong year for stocks in 2016, the no rebalancing strategy showed the best overall average gains. It’s worth noting that no matter which period we looked at, the average returns in each scenario are all very similar, with no more than 40 basis points separating any two of them. But you can see much wider swings when comparing the best and worst periods, for example, there was a 65% spread from best to worst 12-month periods for the portfolio that was never rebalanced compared to a 51% or 52% difference for the three regularly rebalanced portfolios. So rebalancing does appear to have a positive effect on a portfolio’s volatility—you won’t hit the same heights, but you also are unlikely to experience the same losses than an untended portfolio can suffer. A frequently rebalanced portfolio also stays much closer to its targeted allocation, but can still be impacted by periods of high market volatility. Through December 2016, the portfolio that was never rebalanced ended up with a roughly 75%–25% split between stocks and bonds, while the most frequently rebalanced portfolio—most recently in July 2016—ended up fairly close to its original allocation with a 53%–47% stock/bond mix. Sources: Morningstar, Adviser Investments. As you can see in the chart above (which tracks the growth of $100 in hypothetical portfolios split between stocks and bonds using the various rebalancing schemes), over the long haul, returns really don’t suffer that much for the more frequently rebalanced portfolios even though they showed lower average returns over shorter periods. In fact, the difference in the end value of the never rebalanced and the semiannually rebalanced portfolios was $62. That’s hardly an argument for never rebalancing, but it’s not much of one for doing it often, either. So what if you followed Fidelity and Vanguard’s recommendation, and rather than use a set time period to decide your rebalancing strategy, you used portfolio drift? In the table below, we tested what would have happened to that 50%–50% portfolio over the same 30-year period, this time rebalancing when the spread between stocks and bonds exceeded 5% or 10%. Using Portfolio Drift Has Little Impact on Performance # of Trades Avg. Months Between Trades Fewest Months Between Trades Most Months Between Trades Total Return Annualized Return No Rebalancing 0 — — — 1066% 8.53% 10% Spread 17 21 3 75 1041% 8.45% 5% Spread 45 8 1 49 1017% 8.37% Sources: Morningstar, Adviser Investments. If you just look at the number of trades and the average months between, it seems like a pretty doable strategy—with a 5% spread threshold, you would have made a trade about once every eight months, and you would have traded once every year and a half or so with a 10% threshold. But that’s misleading—the frequency of trades varied significantly over the three decades, with a few periods requiring a flurry of activity after longer gaps with no trades. For example, with a 5% threshold, from January 2008 to January 2010 you would have made seven trades as stock market declines regularly pushed the balance of the portfolio towards bonds—meaning that you would have been repeatedly faced with the difficult psychological task of putting more money into stocks as their value was falling. But even if you were that disciplined, and you had made those painful trades—what would it have gotten you? From a return standpoint, not very much. As with the time-based rebalancing schemes, there was very little difference in overall return between the portfolio that was never rebalanced and the ones that were. Former Vanguard Chairman Jack Bogle summed it up pretty well a number of years back: “Rebalancing is a personal choice, not a choice that statistics can validate.” Coming Up This week, we looked strictly at returns and found neither a convincing argument for nor against frequent rebalancing, but there’s more to the issue than just performance. In an upcoming Adviser Fund Update, we’ll have more on the subject, including key concerns that anyone developing a rebalancing strategy needs to consider, so please check back in the weeks ahead. About Adviser Investments Adviser Investments is a full service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trustsA legal document that functions as an instruction manual to how you want your money managed and spent in your later years as well as how your assets should be distributed after your death. Assets placed in a trust are generally safe from creditors and can be sold by the trustee in short order, avoiding the lengthy and costly probate process., institutions and foundations since 1994, and have more than 3,500 clients across the country and over $6 billion in assets under management. 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