Arnott on the Courage to Rebalance

While most investors feel crushed when major bear markets hit, Rob Arnott says that they are missing a key point that turns conventional thinking on its head.

In a piece for, Arnott says that most investors measure wealth in terms of their portfolio’s dollar value. But, he says, a better gauge is “the real spending that the portfolio can sustain over the entire life of the obligations served by the portfolio” — what he calls “sustainable spending”.

As an example, Arnott references the tech bubble. “Many people felt jubilation at the peak of the tech bubble, because they felt so wealthy. And they were — as long as they were inclined to liquidate their holdings and spend before the market lost its euphoria,” he writes. “If they were still investing (e.g., for some future retirement), those new purchases bought precious little yield! Reciprocally, people felt panic and dismay at the 2009 trough of the financial crisis, because they felt as if their assets had been wiped out. And they were — if they intended to liquidate and spend their assets immediately. But, for the buy-and-hold investor, their real income was higher than at the 2007 peak!”

Looking at the century’s worst ten bear markets, Arnott notes that real sustainable spending fell only slightly during the bears, “then recovered massively, on average by 35%, off of their lows just five years after the market trough. In almost every case, our real distributions also achieved new highs, relative to our pre-crisis spending, besting the dividends of the previous market peak by an average of 29%! … For those focused on the level of real spending, rather than the level of prices, the worst market downturns in U.S. history were mostly brief bouts of minor disappointment.”

Arnott says it takes a lot of courage to focus on real spending power rather than the dollar value of your portfolio. But exercising that courage can reap big rewards. By periodically moving out of assets that have performed well and into those that have been hit hard, an investor can increase real sustainable spending during downturns, he says, adding that this can be done within asset classes as well. He offers extensive data on how this strategy has worked over the long haul.