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The Virtue of Daily Rebalancing

By Richard Schmitt

NEW YORK ( TheStreet) -- Wherever you turn, it seems there is always reason to worry. Concern over the Federal Reserve Bank's taper talk, the Syrian crisis, and the looming debt ceiling has rocked the stock market lately. In August alone, stock market volatility, as measured by the Chicago Board Options Exchange VIX, rose by over 20%.

While the U.S. stock market has bounced around, the S&P 500 index has managed to eke out a gain of just 0.1% for the three months ended Aug. 31. In this type of investment environment, a passive investment strategy no longer pays off. No longer can you just let your money blindly ride in stocks without suffering some bumps and bruises along the way. The days of blissful ignorance where no strategy was the best strategy when it came to investing may now have come to an end.

Yet you can reign over this type of market volatility using the time-tested approach of portfolio rebalancing that realigns asset classes growing at different rates over time back to their original or target allocation. Rebalancing's shift from overweight to underweight asset classes within a portfolio captures lasting gains by using proceeds from selling (one asset class) high to buy (another asset class) low.

In a volatile market, the frequency of portfolio rebalancing can make a difference. While the old-school model of quarterly or annual rebalancing may not capture gains from all the market's twists and turns, repeated rebalancing sets up and captures more lasting gains from market volatility.

When invested in mutual funds, it is possible to rebalance a retirement savings portfolio on a daily basis, as long as you abide by the funds' frequent trading rules. So-called 401(k) day trading involves repeatedly rebalancing retirement savings the right way once at the end of each day.

Taking a few minutes a day, you would make one single fund exchange between stock and cash mutual funds based on the change in a market index (such as the S&P 500 index) observed near the market close. On days when the market is about to close higher, you would sell some stock in an amount based on the market's rise. Conversely, on days when the market is about to close lower, you would buy some stock in an amount based on the market's decline.

During the three months ended Aug. 31, 401(k) day trading a balanced retirement savings portfolio initially split evenly between an S&P 500 stock fund and a cash fund garnered a return of 2.1%, compared with the return of 0.1% (both excluding dividends) from holding the S&P 500 index. With less risk, 401(k) day trading generated a 2 percentage point edge in return over holding the S&P 500 in just three months.

The story gets even better over time. From Jan. 1, 2000 through Aug. 31, 2013, 401(k) day trading returned 36.2%, versus 11.1% for holding the S&P 500 index (again both excluding dividends). This 25 percentage point edge demonstrates how the repeated rebalancing involved in 401(k) day trading turns market volatility into lasting gains in retirement savings.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Richard Schmitt is an actuary, adjunct professor at Golden Gate University, and author of 401(k) Day Trading: The Art of Cashing in on a Shaky Market in Minutes a Day.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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