I have read both statements. Both say the same thing.
I don't see what long term versus short term has to do here. I never mentioned those terms. My question would apply to first rebalancing transaction just as it would apply to the next fifty.
Here is my question again and some answers given:
Given that the initial decision to invest in an index fund is based on the idea that current prices of all securities reflect all available information, then on what logic, theory, or idea does one base rebalancing?
Here are some answers in the thread:
1. Index investing is not based on the efficient market hypothesis.
While many here might disagree with this answer, it is nevertheless an answer. My question assumed the efficient market hyposessis to be true -- if this is not true then there is no point in asking further questions about index investing and rebalancing with in the framework of the efficient market.
However this does open a lot more questions. The main one being: why invest in an index fund in the first place?
2. The second answer that I saw was that "asset allocation is something different"
a: "Asset allocation is a different animal. An investor chooses his portfolio, particularly percentage of stocks versus bonds, based on his risk tolerance."
b: "Re-balancing isn't really about market timing or buying assets when they're "cheap". It's about maintaining a diversified portfolio with acceptable risk/return characteristics."
The main phrases being risk tolerance and risk characteristics.
But risk is just a variable in the price of a security. And when you rebalance, under the efficient market hypothesis, you actually move further away from your risk tolerance and characteristic.
One other way to look at the whole situation is this:
When you start investing you make your first transaction of buy and sell orders.
Rebalancing is every subsequent transaction after. Surely then, rebalancing transactions are much more important as they are a much larger part of capital most people will invest.
Don't we owe it to ourselves to have a clear and logical understanding about most of the capital that we plant to invest?
You are asking two different questions. Q1: Market efficiency/security prices. Q2: Index investing.
Markets are not efficient. Embrace it. If they were, hedge funds would not exist, and neither would private equity firms. They both exist.
The way you can think about market efficiency and index investing is this: you disagree with "market consensus".
Example: In the second half of 2013, the market punished REITs because of the fear/expectation of interest rate increases and the effect rising rates would have on REIT profits.
Point #1: If you disagree with the reasoning for the pullback in REITs, you could buy in at a lower price. Same goes for any other situation. If it's clear why the market is driving up/down the price of some security, and if you disagree on the reasoning, you can do the opposite. This does not violate market efficiency.
Point #2: Index investing is the easiest way to get exposure to a certain asset class/sector/etc. Let's say you are bullish on Industrials, but haven't done the research to pick out 5 stocks you want OR don't think any particular names will outperform the broader group. You can buy an ETF/mutual fund/index fund that holds many Industrials, without having to go through the trouble (and additional risk) of specific stocks.
"Don't we owe it to ourselves to have a clear and logical understanding about most of the capital that we plant to invest?"
No. Many people believe it is not possible to outperform the market on a risk-adjusted basis. These people think the best way to make money is to be broadly invested.
I hope this helps?
Personally, I fall in between. I invest in ETFs and various funds within my 401k, but also have a sizable portfolio of individual holdings in my taxable account.