The Four Pillars Of Investing Part 15

2If you decide to experiment with this (which I highly recommend), here's how you do it: On your TI BA-35, enter financial mode by hitting 2nd-FIN. Key in the number of years you'll be saving, then hit the N key. Enter your real rate of return as a percentage. For example, for a real return of 4%, hit "4" then the %i key. Enter the amount you'll be saving each year, change it to a negative number by hitting the +/ key, then hit the PMT key. Enter the amount of your current portfolio ("0" if you're starting from scratch), hit the PV key. Hit the CPT key, followed by the FV key, and your future nest egg will come up. It is slightly more accurate to do this computation with monthly data, but also more complicated-the PMT amount will have to be monthly savings, N will be the number of months (i.e., 360 for 30 years) and %i, the monthly monthly interest rate. For example, for a 4% annual return this value is 0.327. interest rate. For example, for a 4% annual return this value is 0.327.

1The rebalanced return is relatively easy to compute: just calculate the return for each year as the average of the four a.s.sets (or the weighted average if the compositions are uneven), and annualize over three years. i.e., 1.0607 1.191 1.0104 = 1.2765. 1.2765(1/3) = 1.0848. Therefore, the rebalanced return is 8.48%. The unrebalanced return is a bit trickier. Here, you have to calculate the end-wealth after three years for each of the four a.s.sets in the same manner. For U.S. large, small, foreign, and REITs, these values are 1.4147, 1.1436, 1.3385, and 1.0598. The unrebalanced final wealth is the average of these numbers (or the weighted average if the compositions are uneven), which calculates out to 1.2391. 1.2391 = 1.0848. Therefore, the rebalanced return is 8.48%. The unrebalanced return is a bit trickier. Here, you have to calculate the end-wealth after three years for each of the four a.s.sets in the same manner. For U.S. large, small, foreign, and REITs, these values are 1.4147, 1.1436, 1.3385, and 1.0598. The unrebalanced final wealth is the average of these numbers (or the weighted average if the compositions are uneven), which calculates out to 1.2391. 1.2391(1/3) = 1.0741. Therefore, the unrebalanced return is 7.41%. The calculation of the unrebalanced return is the source of not a little mischief. Many mistakenly calculate it as the weighted average of the annualized returns. This is incorrect and will always yield a value less than the rebalanced return. Rest a.s.sured that it is possible to lose money rebalancing, although it does not happen often. = 1.0741. Therefore, the unrebalanced return is 7.41%. The calculation of the unrebalanced return is the source of not a little mischief. Many mistakenly calculate it as the weighted average of the annualized returns. This is incorrect and will always yield a value less than the rebalanced return. Rest a.s.sured that it is possible to lose money rebalancing, although it does not happen often.

2The easiest way to think about this is to imagine that you have $1 million in your retirement portfolio, split 50/50 between two a.s.sets, A and B. If a.s.set A goes up 20% and a.s.set B goes up only 10%, then you'll have $600,000/$550,000 of A/B. If you need $50,000, then taking it all from A gets you back to 50/50. If you need more than $50,000, then you will have to sell a bit of B as well. If you need less than $50,000, then you will still have to rebalance a bit from A to B to get back to 50/50.

1Tom Lauricella, "The Stock Picker's Defeat," Wall Street Journal, Wall Street Journal, December 10, 2008, p. C1. December 10, 2008, p. C1.

2 Source: Morgan Stanley Capital Indexes, Source: Morgan Stanley Capital Indexes, www.mscibarra.com.

3 Philippe Jorion and William N. Goetzmann, "Global Stock Markets in the Twentieth Century," Philippe Jorion and William N. Goetzmann, "Global Stock Markets in the Twentieth Century," Journal of Finance Journal of Finance 54, no. 3 (June 1999), pp. 953980. 54, no. 3 (June 1999), pp. 953980.

4 Jeremy Siegel, Stocks for the Long Run (New York: McGraw-Hill, 2007), pp. 124125; William J. Bernstein and Robert D. Arnott, "The Two-Percent Dilution," Jeremy Siegel, Stocks for the Long Run (New York: McGraw-Hill, 2007), pp. 124125; William J. Bernstein and Robert D. Arnott, "The Two-Percent Dilution," Financial a.n.a.lysts Journal Financial a.n.a.lysts Journal (SeptemberOctober 2003), pp. 4755; Larry Speidell et al., "Dilution Is a Drag . . . The Impact of Financings in Foreign Markets," (SeptemberOctober 2003), pp. 4755; Larry Speidell et al., "Dilution Is a Drag . . . The Impact of Financings in Foreign Markets," Journal of Investing Journal of Investing 14, no. 4 (Winter 2005), pp. 1722; Jay R. Ritter, "Economic Growth and Equity Returns," November 1, 2004, working paper; and Elroy Dimson et al., 14, no. 4 (Winter 2005), pp. 1722; Jay R. Ritter, "Economic Growth and Equity Returns," November 1, 2004, working paper; and Elroy Dimson et al., Triumph of the Optimists Triumph of the Optimists (Princeton, N.J.: Princeton University Press, 2002), p. 156. (Princeton, N.J.: Princeton University Press, 2002), p. 156.