Note To Self: Rebalance Your Portfolio!

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It’s been over a year since I came up with my current asset allocation mix, and I should really rebalance my current portfolio to match those percentages again. It really should only take a few minutes of spreadsheet math and some clicking online, but I’ve been plotting out a few long-term asset allocation changes in the meantime and I’ve been putting it off. I really must do one or the other soon.

Rebalancing is a way to maintain the risk/reward balance that you have chosen for your investments, and also forces you to buy temporarily under-performing assets and sell over-performing assets (buy low, sell high). How often one should re-balance their portfolio depends on a few factors. In taxable accounts, rebalancing will create capital gains/losses and therefore tax consequences. In some brokerage accounts, rebalancing will incur commission costs or trading fees. As for me, the vast majority of my retirement portfolio is in tax-sheltered accounts and in mutual fund accounts which are not subject to transaction fees. Some of my funds have redemption fees, though.

After that, some people rebalance on a certain time-based schedule – for example, once every 6-months, every year, or every 2 years. Others wait until certain asset classes shift a certain amount away from their desired targets. I will dig up some good articles on this topic later (here is one math-intensive article to start), but after my previous research I had settled on an annual rebalancing schedule. Of course, that was almost 15 months ago. 😳

If you rebalance, what is your criteria?

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  1. I rebalanced earlier in the year for the first time in years!

  2. I rebalance every 6 months, at least i try to do this. 😉

  3. Chris CPA says

    Rebalance once a year. It can add 1 to 3 points to your return which adds up!

  4. For what it’s worth, although TIAA-CREF has been driving me nuts on service recently, their “rebalance on my birthday” feature is pretty nice. And my birthday happens to be coming up; time to rebalance.

  5. The annual rebalance is a great scheme: put it in your scheduler and fuggedaboudit. But if you are a whack-o, one of my OTHER pet schemes is: asymmetric rebalancing.

    In simplest form, imagine a 50/50 stock/bond mix. Generally speaking, stocks outperform bonds in the longer-term. If you rebalance annually, you might be selling yourself short (i.e., not letting stocks run to their full potential).

    Asymmetric rebalancing takes these trends into account, signalling a rebalance not by TIME, but by some trigger differential, e.g., when stocks hit 57% (7 pps on the upside) or 48% (2 pps on the down) of the stock/bond mix.

    Due to asset trends and the different lengths of bull/bear cycles, it is advantageous to let the stocks drift higher before a rebal. Looking at the data 1960-2000, a +7/-2 gives close to a +10 percentage point advantage over a similar 50/50 mix rebalanced monthly. (Yes, this is a single data point in a single rebal scenario, but what do you want for a comment on a blog?!)

    Things get more complicated when different asset classes are introduced (duh!), and you’d have to do some fancy arithmetic to figure out the equivalent per-asset-class movement ranges (gee, my 3.5% allocation to Japan is +38 bps today; do I rebalance?) but I am sure there is research available out there.

    This is more useful in the institutional world, where the entity might be looking at things in a very top-down way.

    One other point to take from my note is that letting things drift for a coupla months longer than intended (e.g., 14 vs. 12 months) can be a good thing!

  6. Reading the first comment (and thinking about others); I am clearly obsessive: I have to work AGAINST rebalancing (or otherwise modifying) my portfolio.

    I may have commented about this before; if so, sorry!

    Back when I found myself mucking around with things about once a month (!), I finally built a “core and satellite” strategy so as not to end up hurting myself. I put the bulk into some core themes, and then allocated to a number of low-correlation, risky assets (using some form of portfolio theory stating that a portfolio of such assets will, non-intuitively, exhibit lower risk/higher returns etc. etc.).

    That way, I could mess around at the margins (gee, 3% in Biotech…or how ’bout 5!) without suffering major damage. I still *feel* like I am doing something, but in reality I am having (I hope) only marginal effect. I *do* allow myself a semi-annual full analysis and, if circumstances warrant, reconstitution.

    I recommend this method–or variations thereof–to other inveterate meddlers (Yah, dude, put, like, 75% in Vanguard Wellington, and, you know, like, 5% each in your top 5 fave whack-o picks! Rock on!).

    [ed. note: my own portfolio is more like 1/3 in core holdings and 2/3 in my top 22 fave whack-o picks; such an embarrassment!)

  7. Rebalance every 6 months but only if a category is more than 5% off. Even then I’ve had situations where only one category is off of 5% but to balance I’d have to spread it out over the remaining categories. Just too much work tracking wise to move such small percentages around. For the past 3 years I’ve mainly rebalanced by shifting how the new money is going in than actually rebalancing the 401k.

  8. Ted Valentine says

    I was told by a pro that if you rebalance too often “you don’t give the dogs a chance to run.”

  9. Ted Valentine says

    Anon Bosh – Your potfolio sounds like a football team. Wellington is the OL and DL and the rest of your players are the wide receivers, running backs, and special teamers. You’re sending new players in all the time with new plays.

    In fact, you should write a book on that. Call it the “Football Coach Portfolio” and back test the data to show how it beats the S&P over XXXX years.

  10. Chris H. says

    There was recently a study done by some folks at Motley Fool that indicated rebalancing once actually produces weaker results that rebalancing every three years. Similarly, rebalancing every five years returned weaker results that rebalancing every three years. The argument as I understand it is that economic cycles tend to last on the order of three years, so if you leave your portfolio untouched for three years, you absorb the full effect of the up cycles. I believe relancing every three years produced on the order of 90% of the returns of a portfilio that was never rebalanced, but with substantially less volatility. Of course, the unrebalanced portfolio was the winner, but the charts showed that it was a wild ride 🙂

  11. Jon I have a question for you,

    I am curious as to why you would sell some of the funds you own in order to maintain your target asset allocation. I would think a more logical approach would be to direct your newly increased combined income into the funds where you need to increase capital. I am no expert (college student) and would like to know what you think about not selling anything and just being extremely picky with your future (hopefully larger) contributions.


  12. I have done some make-overs this year, but they were not exactly rebalancing, but rather reducing the number of holdings and being more efficient. If I rebalance, I will choose to invest a little more into the category that’s below the target instead of selling the outperformers, and the frequency won’t be less than a year.

  13. Tyler, that’s a very good comment, and another great way to keep my asset allocation in balance as well. I plan to implement my future contributions carefully. But I don’t know how much I will be contributing in the near future to my retirement funds. I still need to save up for a downpayment, closing costs, extra money for repairs/furniture/startup costs, and keep an emergency fund.

  14. T. Rowe Price has a really nice feature in my 401(k) plan where they will automatically rebalance my assets to the allocation I specify at the interval I specify. I wish my Roth IRA and taxable accounts had this feature! They both would incur commissions for rebalancing so I mostly use the method of adjusting my contribution to get assets back in order.

    Chris H – What article are you referring too at the Fool? Most people agree that a properly balanced portfolio increases return and lowers volatility. There’s much debate on what the proper frequency/method to achieve this is but I haven’t heard much argument that rebalancing actually reduces return. I think whoever wrote that article didn’t know all that much about investing.

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