Rebalancing your portfolio

[Barefootwoman]

Do you have a strategy you follow for rebalancing your portfolio to get back to your target asset allocation?

I believe Modern Portfolio theory promotes rebalancing once per year or even less, but I see others who rebalance on market dips....so there seem to be different methods or strategies out there.

I was rebalancing once per year until this past year, when there were several dips. Doing so has boosted the overall value of my portfolio, but sometimes I wonder if this is just mental gymnastics (there are other words for this, but I'll use the politest term I can think of at the moment).

 

[ashishsg]

Finance or miles/points portfolio?

 

[Barefootwoman]

Finance or miles/points portfolio?

finance but now curious as to how it would apply to miles/points?

 

[addemoh]

On the finance side of things, I tend to base rebalancing on the weighting of the portfolio rather than the time between trades.

For example, if you have a portfolio that is 80% stocks and 20% bonds, I would rebalance once that portfolio deviates by x% (say 5% for example). So if the portfolio changes to 60% stock and 40% bonds, it is time to sell some of your bond positions and buy stocks that have gone on sale, regardless of when your last rebalance was. Conversely, if your asset allocation is 83% stock and 17% bonds, I would not yet make those trades.

With this mindset, what becomes important is how frequently you take the time to review your positions and how you are positioned. In simple terms, if you have a well diversified ETF based portfolio, you are not as likely to see large sporadic deviations. If you are stock picking/betting, you are more likely to see variability in the value of your positions. However, this is an entirely different conversation.

Not sure on miles/points rebalancing. I tend to lean towards accumulating any points you will use, then using them for amazing experiences!

 

[Matt]

Factors to consider are: how many funds you hold (granulation) and whether it is taxable or not.

The reason for this is that there is never simply rebalancing in a taxable account, it is also a tax loss harvest opportunity when done correctly.

I use percentages for both advantaged and taxable, and additionally periodically for taxable, as time matters for that with annual cut off dates.

 

[Barefootwoman]

Factors to consider are: how many funds you hold (granulation) and whether it is taxable or not.

The reason for this is that there is never simply rebalancing in a taxable account, it is also a tax loss harvest opportunity when done correctly.

I use percentages for both advantaged and taxable, and additionally periodically for taxable, as time matters for that with annual cut off dates.

Did some more digging yesterday and found a reference from one of Bill Bernstein's books and FWIW, he mentioned a 5% divergence for non taxable accounts and 10% for taxable, but not a hard and fast rule, of course.

 

[Matt]

Did some more digging yesterday and found a reference from one of Bill Bernstein's books and FWIW, he mentioned a 5% divergence for non taxable accounts and 10% for taxable, but not a hard and fast rule, of course.

I think that without deeper understanding of rebalancing, the rule isn't just (not hard and fast) but without purpose. There needs to be an explanation of why it is different for taxable and non taxable. FWIW, I would propose that with smart rebalancing, it shouldn't be anything like as high as 10%.

Before even thinking about percentages, it is important to understand what rebalancing means - why would you need to rebalance? There are several ways that you might need to rebalance:

1. portfolio drift that rebalancing creates a cap gain
2. portfolio drift that rebalancing creates a cap loss
3. portfolio drift that rebalancing creates neither through injection of external funds

They all create different 'rules'. I think the 10% one might apply to a gain, but I would wherever possible not create that gain rebalance unless it was within an advantaged account. Conversely, there is loss rebalance, which the 10% rule in taxable is totally illogical.

Example, Date 12/14:

Stock market down 3% in a week, bond market unchanged (similar to last week)
Portfolio of 60/40 stocks to bonds, value of $100K

Impact of rebalance with TLH
60K stocks became $58,200
40K bonds remained $40K
Total account value dropped from $100K to $98.2K, unrealized loss of $1.8K

If you rebalanced with a TLH here, even with a minor shift, you capture $1.8K of losses, which could reduce your OI each year (to a cap of $3K per year) or other cap gains. The event itself might be consider a pure TLH, but with proper execution you can also rebalance if you so choose.

This is why I can never look at rebalancing in isolation. Also, when I manage investments, I create a granular plan which creates more opportunities to TLH when rebalancing, which increases captured losses.

Rebalancing is just an attempt to 'sell high, buy low' in many regards, and is often considered a long term strategy that seems to work... but when you consider it a short term strategy for capturing losses, the approach changes.

 

[LearnMS]

Slightly off topic - After a long time I looked at my 401k performance. By Christmas week, I will be maxing out 18k limit. I see that the year to date return is negative 2.5%. I lost some return this year. Mine is 90/10 stocks/bond ratio. These are in target retirement fund with blended index funds option.

I was told to never look at retirement funds but just keep maxing it out every year. From above, should one try to look at rebalancing 401k acct as needed?

 

[Matt]

Slightly off topic - After a long time I looked at my 401k performance. By Christmas week, I will be maxing out 18k limit. I see that the year to date return is negative 2.5%. I lost some return this year. Mine is 90/10 stocks/bond ratio. These are in target retirement fund with blended index funds option.

I was told to never look at retirement funds but just keep maxing it out every year. From above, should one try to look at rebalancing 401k acct as needed?

If you are invested in target date funds they are rebalanced for you.

 

[LearnMS]

If you are invested in target date funds they are rebalanced for you.

Yes, but I see an option to change the elections. Would it be wise to change the election from 2045 target retirement funds to 2035, for example? It will change the stock-bond mix and there will be more of mix.

 

[Matt]

Yes, but I see an option to change the elections. Would it be wise to change the election from 2045 target retirement funds to 2035, for example? It will change the stock-bond mix and there will be more of mix.

That depends on what happens to stocks and bonds in the future.

Since we don't know that, you need to decide what you are comfortable with from a risk perspective.

 

[zeppoloveskafka]

Yes, but I see an option to change the elections. Would it be wise to change the election from 2045 target retirement funds to 2035, for example? It will change the stock-bond mix and there will be more of mix.

From what I recall, the difference between the two (for Vanguard at least) is very minimal at this point. It only really starts to matter as you get closer to retirement. I wouldn't worry about it.

However I'm not a big fan of complex portfolios or rebalancing in general. It's all a gamble, so the best you can do is focus on making money and not spending money (far more controllable), and just put your money in a risk you are comfortable with low fee account. The time to start thinking about being less aggressive probably shouldn't be until 3-10 years before retirement.

 

[Matt]

and just put your money in a risk you are comfortable with low fee account. The time to start thinking about being less aggressive probably shouldn't be until 3-10 years before retirement.

I generally agree with your comment (and do agree with the notion of earning and spending controls rather than returns) however, the key is that risk should never be outside of your comfort zone, or at least not too far out. If you think about it, the quoted part of your comment contradicts itself here to highlight the point:

• Risk you are comfortable with
• Less aggressive 3-10 years before retirement

If it is risk you are comfortable with, it wouldn't need to be less aggressive.

The glidepath concept is important here, starting more 'risky' and reducing, but even with that in play you shouldn't be in a place where you are worrying about the day to day market movement.

 

[LearnMS]

I max out 401k every year and also the HSA. My 401k was hit hard in the recent months due to the fluctuations we are already aware of. Some of my colleagues changed their elections, but won't divulge for obvious reasons. Personally, I wouldn't react to such knee jerk reactions in the market for a 30+ year old. But if there's anyone who feels otherwise, would be curious to know. Completely agree that's it's an individual's personal decision to manage their own money.

 

[Touristtrap]

IME it all depends how busy is the person and individual's financial situation.

I am lucky that my 401k offers automatic rebalancing when assets are more than 5% off.

Our Roth IRAs are in the most aggressive investments as we don't plan to use it in next 20-30 years.

Our taxable accounts we rebalance with a new money perpetually (monthly).

For those less experienced we stayed the course over the last 15 years and never tried to time the market, even in 2008. I still remember investing $1500 in the wife's Roth IRA (S&P 500 @ 1550) in 1998/9. It was tough to swallow that S&P did not cross that number until 2-3 years ago but we stayed the course. No regrets here as other investments did much better.

These days I don't even check my 401k more than twice a year. It is on a cruise control and it will stay like that until we adjust our asset allocation further more.

 

[Jslectronic]

Would it be wise to change the election from 2045 target retirement funds to 2035, for example?

I would also check to see if the fund mix for your 401k includes any low fee tracking fund for both equities and bonds. For me i know all the target funds have management fees in the 1.5% range whereas the fee for the tracking fund is 0.07% or essentially free in comparison.
Over the long haul if you put in an hour a year to do simple rebalance (like bond percent equals age and everything else in domestic stock) you will gain a lot by avoiding those fees!!! And imo your returns should be just as good

 

[naroowal]

Realize this topic is a little old but wanted to chime in:

My situation: 10 year old 401K i contribute to the max every year. So non-taxable as of now.

I have a chart with my %age of equities, bonds, and money market for a year laid out for the next 30 years. I didnt use the 100-age rule but I am comfortable with a more aggressive ratio of equities. Every year the %age of equities drops by a certain amount (in my case it is 1%).

I rebalance anytime the %age is off by 2% whether it be in the positive or negative direction. The key is patience and perseverance. I feel this strategy has led to good results for the last 5 years but the last 5 years have also been a good bull market. I am hoping to keep doing this. I understand it is not very different from a target 20xx fund but this gives me good diversification since our 401K has good variety of funds.

Thoughts?

 

[Matt]

Realize this topic is a little old but wanted to chime in:

My situation: 10 year old 401K i contribute to the max every year. So non-taxable as of now.

I have a chart with my %age of equities, bonds, and money market for a year laid out for the next 30 years. I didnt use the 100-age rule but I am comfortable with a more aggressive ratio of equities. Every year the %age of equities drops by a certain amount (in my case it is 1%).

I rebalance anytime the %age is off by 2% whether it be in the positive or negative direction. The key is patience and perseverance. I feel this strategy has led to good results for the last 5 years but the last 5 years have also been a good bull market. I am hoping to keep doing this. I understand it is not very different from a target 20xx fund but this gives me good diversification since our 401K has good variety of funds.

Thoughts?

I think that the age in equities concept is not savvy.

If you are 50 and need $87k in retirement, prior to factoring social security, and have $1.6m in a 401k..

(Inject your own variables for the numbers)

Should you be 50/50? If so, why?

 

[Modern Nomad]

Another thought on rebalancing: If you're making regular contributions to a personal investment account, couldn't you rebalance by adjusting the allocation of your contributions? For example, say your goal is to have a 80/20 portfolio that has grown to 85/15 over the past few years. Instead of selling the 5% excess of your stocks, you focus the majority of your contributions to bonds. This would allow you to avoid potential higher taxes from amount of capital gains (FIFO) on the stocks. This is a simplified example that doesn't take into account market conditions at the time of rebalancing.