Rebalancing Your Portfolio

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How often should you rebalance your investment portfolio?  Some don’t see a need to rebalance their portfolio ever.  Their thinking is: why mess with a good thing?  If winners continue to rise, why bother taking those profits and allocating them into lesser-performing stocks?

 

Let me start off by saying I am advocate of portfolio rebalancing.  The primary goal of rebalancing your portfolio is to reduce your risk relative to your targeted asset allocation.  Over time, different asset classes result in different returns, changing the portfolio’s asset allocation.  In order to recapture a portfolio’s original portfolio asset allocation, the portfolio should be rebalanced yearly.

 

Some argue that the market is perfectly rational, so why even bother?  Here’s the thing about it.  Rebalancing smooths investment returns.  As you may know, all asset classes go through cycles.  There are four main asset class cycles.

 

Recovery (Early)

During a recovery, risky stocks, such as high-flying tech companies, normally perform very well.  In turn, investors are rewarded for taking on additional risk.  Stocks during this time period normally greatly outperform government bonds.

 

In addition, high-yield bonds, also known as junk bonds, outperforms investment-grade bonds, also known as AAA bonds.  High-yield bonds can sometimes deliver the highest returns in the asset class.

 

Expansion (Mid)

Depending on who you ask, the US market is either in expansion or about to transition into the slowdown portion of the cycle.  During this period, stocks are normally the best-performing asset class due to the acceleration from the economy that causes rapid earnings growth and an increase in profit margins.

 

High-yield bonds continue to typically outperform investment-grade bonds, while government bonds are the worst-performing asset class because of rising inflation concerns and tightening monetary policy.

 

Slowdown (Late)

This phase is one of the toughest to predict as it makes for an uncertain time for asset-allocation decisions.  Stocks and bond markets all deliver roughly a similar performance that is in line with savings account rates, which have risen due to tightening monetary policy decisions.

 

Contraction (Recession)

Finally, during a recession, government bonds are the best-performing asset class as investors become risk averse. In this environment, you will see people jumping out of the stock market and corporate bonds and piling into government bonds.

Source: Fidelity Investments (AART)

 

A study by the Vanguard Group compared rebalanced portfolios with those that were not, from 1926 through 2009.  A portfolio that was never rebalanced started a traditional asset allocation of 60% stocks and 40% bonds.  Over time, it became heavily weighted to 84% in stocks and just 16% bonds.  For those that are getting closer to retirement, by rebalancing your portfolio, you might be able to reduce volatility by 17%.

 

So When Should You Rebalance?  

According to Vanguard, their findings indicate that there is not an optimal frequency or threshold when rebalancing your portfolio.  They state, “This paper demonstrates that the risk-adjusted returns are not meaningfully different whether a portfolio is rebalanced monthly, quarterly, or annually.  As a result, we conclude that for most broadly diversified stock and bond fund portfolios (assuming reasonable expectations regarding return patterns, average returns, and risk), annual or semiannual monitoring, with rebalancing at 5% thresholds, is likely to produce a reasonable balance between risk control and cost minimization for most investors. Annual rebalancing is likely to be preferred when taxes or substantial time/costs are involved.”

 

So with that said, I like to rebalance when an asset class weighting has changed by five percentage points.  Like dollar-cost averaging, the best thing about rebalancing your portfolio this way is that it removes the timing of the market from the process.  As I’ve reiterated before, timing the market is a fool’s game.

 

I know some experts say to do it monthly/quarterly/yearly.  Here’s my thinking.  If your portfolio has only moved from 60/40 stocks to bonds to 59/41 stocks to bonds, that’s really unsubstantial.  Instead, I’d wait for your portfolio to hit that 5% mark before I change it and then, only annually.  

 

According to this chart from Vanguard, you can see that if you did this that over past 90 years that this would have resulted in a rebalance every three years.

portfolio rebalancing

 

Some may ask why they would want to buy stocks and bonds when they are down.  But then I saw this baseball quote from Gary Thayer, of Wells Fargo Advisors: “Not a lot of people hit the ball to right field. But you don’t take the right fielder out of the game.”  Makes sense to me.

 

So are you going to rebalance your portfolio this year?  Do you agree with the premise?  Share your thoughts below.

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Welcome to the website. A mustard seed is a very small seed but astonishingly grows very large over time. My hope is that through your financial journey that your small investment in time, money and faith will grow beyond anything that you could ever imagine.



26 Comments

  1. I like to rebalance annually. I only calculate my net worth quarterly, so I don’t track the swings up and down all the time. I actually wrote the annual rebalancing into my Investment Policy Statement so I’ll be sure to do it every year. Why annually? Well it’s part laziness – it takes a while for me to calculate % in each asset class in each account – part simplicity, and partially because I also have an annual allocation shift built into my IPS. So I can do both at once.

    Your method of rebalancing when you hit a percentage threshold of assets being out of whack is also a good method that works well for some people. I know OG on Stacking Benjamins and The Money Guys use that method as well.
    Liz@ChiefMomOfficer recently posted…Kids Making Their Own Board Game – A Lesson in Frugal CreativityMy Profile

    • Thanks for sharing Liz!!!

      I think as long as you have some sorta of plan in place it’s better than nothing which unfortunately too many investors.

      I’m didn’t know that OG and The Money Guys follow a similar strategy. Thanks for sharing!!!

  2. Nice overview MSM! From my side, since I’m in an early wealth building phase, I solely do rebalancing via new purchases towards assets that need some boost. A +-5% threshold is probably a good guideline, this is the same I set for myself.
    I think rebalancing can be a more interesting question once you already built up your portfolio and live from it rather than add to it. I made an example how it would’ve worked out under an extreme condition like the 2008-2009 crisis. In short, the timing of the rebalancing is important (and a matter of luck), plus the difference in results is not that significant. If you’re interested in the details, please have a look: http://www.theroadtoonemillion.com/portfolio-reallocation-during-early-retirement/
    Will you personally do any rebalancing at year end?
    Roadrunner recently posted…Dividend SnowballMy Profile

    • Thanks for sharing Roadrunner!!!

      Always a great read from you.

      This year I will not need to rebalance since the Trump Bump has helped some of my poorer performers for the year jump up. So since nothing it too out of balance I will ride through the year and add some new money in January which will naturally rebalance.

  3. The real key is to rebalance on a schedule. You can rebalance too often and cost yourself a lot of money. I rebalance with new money rather then sales, periodically shifting all new money and reinvestment to one class or other. It takes a little longer to rebalance but it lowers my costs.
    FullTimeFinance recently posted…The World of FreeMy Profile

    • Thanks for sharing FTF!!! That’s really smart to rebalance with new money. Since I won’t hit my 5% threshold this year but am getting closer to that threshold. In January I plan to add some new money which should get closer to my original allocation 🙂

    • Thanks for sharing Go Finance Yourself!!!

      Rebalancing annually is definitely easy to remember and definitely smart. I wish I had done this earlier in my investment journey 🙂

  4. I don’t re-balance. But that’s only because at this point in my investing career I have all of my money in VTSAX. I’ve made the decision that during the early accumulation phase I will just dump everything there and then in the later accumulation phase I will decide how I want to diversify for more stability. I don’t know that that is necessarily the option that will make me the most money, but it should be relatively close and it saves me a ton of time.
    Matt @ Optimize Your Life recently posted…You Have More Money Than You ThinkMy Profile

    • Thanks for stopping by and sharing Matt!!!

      It makes a lot of sense what you are doing right now. I hadn’t even considered if someone had invested in the VTSAX and not needing to rebalance 🙂

      Thanks likes always!!!

      • NIce overview MSM! I just rebalanced my 401k this weekend since I also do this annually. I am in a similar situation as Matt in terms of being in my early accumulation phase with essentially 100% in stocks.

        However, because my investments are spread out between different accounts, this means I am trying to balance my broad US vs. international index funds (since my employer’s 401k doesn’t offer VTSAX). So although I try to rebalance throughout the year as I invest more money, I still want to make sure I’m not too heavily weighted with either US or international funds.

        The biggest problem I have is feeling confident in the percentage I want to maintain. I know that many of the large US companies are international companies, so I try not to over think this, but I still question whether I have found the right percentage to rebalance to.

        • Asset allocation is always a tricky one and there have been a ton of studies done on the perfect asset allocation.

          I think the bottom line for me is the allocation that allows me to sleep well at night.

          So whatever gives you the most confidence is probably the right decision for you 🙂

          Thanks for stopping by and sharing!!!

  5. Great topic. I take a deep look at the passive portfolio on a semi-annual or annual basis to see if any positions are out of whack for rebalancing. I typically don’t like to rebalance something in my portfolio unless the allocation is more than 3 percentage points above the target allocation (because I’d hate to pay the taxes).
    Andrew recently posted…How To Become More Confident Like Harvey SpecterMy Profile

    • That’s a great perspective Andrew. I think too often the tax portion is not always something that we think about!!! That’s probably why the experts recommend the annual rebalance to cut down on the short term capital gain taxes people have to pay.

      Thanks for sharing!!!

  6. I’ve got no problem with rebalancing when the drift gets that high, but I do see one problem. Unless you’re using a robo-advisor, you’ll probably need to put in more time monitoring your investments in order to know when to rebalance, right?

    I dunno, I prefer people to just not even look at it really, just in case they get freaked out when they see something they don’t like. I think automating quarterly rebalancing or even yearly rebalancing is fine for like 99% of people, and can help avoid people tinkering too much with their investments.
    Financial Panther recently posted…Making Money With Airbnb: Why I Rent Out Our Guest RoomMy Profile

    • Thanks for sharing Financial Panther. I definitely agree with you that in some cases it’s better not to look at your portfolio at all.

      I definitely know too many people that tinker and mess around when they shouldn’t and it ends up costing them.

      I will be curious in the future as robo-advising becomes more popular how that will impact people’s trading. Hopefully the less is more strategy will really pay off 🙂

      Thanks again for stopping by!!!

  7. I use the 5% threshold as well. I check my portfolio quarterly, but I only rebalance when the allocations get out of whack. I don’t think I’ve had to rebalance much in over a year, but if the market continues its “Trump Rally” I may have to rebalance soon.
    SomeRandomGuyOnline recently posted…Biggest Investing Challenge?My Profile

    • Thanks for sharing!!! The Trump Bump has definitely helped some of my portfolio which has actually caused me not to have to mess with things 🙂

      So clearly you were/are having a better year than me!!!

  8. I let Vanguard to the rebalancing. I have one of those retirement target dates. Since I can’t really do much until 59 1/2, I set that as my ‘retirement’ date, even though I long left the corporate world.

    I’m an engineer and construction manager, so real estate suits my investing interests much more so than the stock market. That is where I put my own efforts into.
    Primal Prosperity recently posted…Shut Up And CalculateMy Profile

    • Thanks Primal!!! I remember you said you asset more of your time and energy towards real estate which is excellent. Having a diversified investment portfolio is always a good thing 🙂

      I tried the target fund for awhile but for whatever reason I didn’t like some of the allocation of the years. So I changed back to doing it manually.

      Thanks for sharing your perspective!!!

  9. Nice article, MSM.

    The Vanguard study’s interesting. I saw something similar a while back with conclusions largely aligned with those in the Vanguard table you show. Which is part of why I’ve tended to think of rebalancing as an annual exercise. It’s a heckuvalot simpler to do tax loss harvesting and reallocating as a one-time event rather than monthly/quarterly/daily(!) anyhow. And, yup, those transaction fees can be nasty too.

    I like your idea about not bothering unless allocations have moved +/-5%. Nice stuff, and thanks for the compelling read.
    FinanciaLibre recently posted…Gym Libre: The Ultimate Home GymMy Profile

    • That’s a huge compliment coming from you FinanciaLibre 🙂

      I think the 5% rule is some respects is slightly harder to remember than the annual review, since you’d have to monitor a bit more closely but could potentially save on fees in the long run.

      Anyway thanks for sharing and I’m glad to hear that Vanguard’s study lines up with what you have read as well 🙂

  10. I very rarely sell some of my holdings so the rebalancing happens by using cash to add new positions. When markets tank, I tend to invest a larger amount, surging stock prices let me restrain with adding new money to my portfolio.
    Selling stocks has several downsides in my view: transaction costs and you never know if these stocks won’t show superior results after being sold. Good companies tend to increase their dividends over time, and being reinvested such holdings become real compounding machines. But this needs time and patience. When such holdings are sold in order to rebalance the portfolio progress made over several years is at risk to be eliminated.
    Great post. Thanks for sharing.
    Cheers

    • Thanks for sharing Financial Shaper!!! I think it’s incredibly smart to use new money as a “rebalance” for your portfolio and it totally makes sense if you have the cash available.

      I am planning on adding some new money this coming year, especially in light of the Trump Bump!!!

  11. For sure, re-balancing is a good thing. However, I don’t do it often enough (my bad). I usually do tax loss selling to offset the capital gain at the end of each year so I can minimize my annual income tax. In a way, this is re-balancing for me. One thing about re-balancing is the size of your portfolio. If you have $50,000 or less, it’ll be tough to justify the cost that you’ll incur.
    Leo T. Ly @ isaved5k.com recently posted…Freedom 48 Investment Toolkit: Foreign Market Investment BasicsMy Profile

    • I know a lot of people try to get into the habit of reallocation once a year. I found that since I look at my portfolio throughout the year that it’s easy to look at personal capital and see if the portfolio has gotten outside it’s asset allocation of 5%.

      It’s normally a quick look and I haven’t had to do it for awhile. Thank you bull market 🙂

      But I’m sure it’s just a matter for time.

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