How do you rebalance your portfolio?

[disneysteve]

Traditionally, I have chosen to rebalance my portfolio by redirecting new money going in. If large company stocks were overweighted, for example, I put new contributions toward small company stocks or foreign stocks or whatever segment needed to be brought back up. As our portfolio gets larger, though, that is getting harder and harder to do because the amount needed to rebalance by that method gets higher and higher.

I'm in the midst of reviewing all the year-end stuff and rebalancing, especially with the huge run up in stocks this year which has really thrown off some of the allocation beyond the point that I can rebalance with new money.

My question is this: When you are actually selling assets in one class in order to rebalance, do you sell all at once and buy the lacking class all at once? Do you sell all at once, park the money in a money market and dollar cost average into the other class? Do you sell off gradually and buy in gradually? Or some other method.

[jIM_Ohio]

Steve- I rebalance with new contributions only

when my portfolio gets to be so large that contributions do not impact asset allocation percentages, then I will consider doing any of these steps

1) Holding more cash- easier to direct cash to right places
2) directing all capital gains and dividends and interest to a common money market account
3) selling holdings and buying what was out of balance


Because 45% of my holdings are in a dividend fund, I expect that I can rebalance with dividends easily... assuming the dividends earned are higher than my annual contributions (and dividend funds usually pay a quarterly dividend, so that adds complexity to problem as well).

[disneysteve]

3) selling holdings and buying what was out of balance

That's the part I'm wondering about. Do you sell and buy all at once? Let's assume we are talking about a retirement account so taxes aren't an issue.

Let's say I need to increase my international equity position by $10,000. Do I put 10K in all at once or do I park part of the money in my MMF and feed in say 2K/month for 5 months? Not sure which would be best.

All of this is probably still mostly hypothetical but I see where this will become a problem as the portfolio grows.

[kv968]

Funny you should bring this up Steve because I was just doing some rebalancing today. I chose to take whatever I had to out of funds that did better than the others and parked the money in a MM account for now. I'm most likely just going to dump the smaller amounts into the funds that only need a little and DCA somewhat into the ones that need more. A little bit of "market timing" I guess you could say

[kork13]

In a tax-advantaged account (IRA, 401k, etc), I'd say it's easier to just sell and buy to re-balance. You won't pay taxes based on the results of the transaction, so why not do what's easiest?

In a taxable account, I normally re-balance by making one-time deposits to adjust as needed. Every month I add a small amount of cash into a MMF, which is what I use to adjust as needed. Saving it away ahead of time makes it simpler for me, while still maintaining some liquidity if necessary (it really serves as a sort of slush fund -- it can go to investments, savings, or spending, pretty much as I need it.)

One consideration, though, is if you want to farm gains/losses... But then, unless you're planning on changing your overall asset allocation, you generally won't have losses to take....


::sigh:: I've put off my re-balancing so far, I suppose I'll try to take care of it this weekend.

[jIM_Ohio]

That's the part I'm wondering about. Do you sell and buy all at once? Let's assume we are talking about a retirement account so taxes aren't an issue.

Let's say I need to increase my international equity position by $10,000. Do I put 10K in all at once or do I park part of the money in my MMF and feed in say 2K/month for 5 months? Not sure which would be best.

All of this is probably still mostly hypothetical but I see where this will become a problem as the portfolio grows.

You would want to do it all at once. That is what I have done the few times I have sold in past, and here is my logic.


The goal of the rebalance is three fold

1) maintain asset allocation
2) buy low- sell high
3) maintain risk profile throughout "all points" in time- whether triggered by a percentage from normal allocation, or at a pre-established time.


If you delay the purchase none of those 3 criteria are true until you buy back in.

[disneysteve]

That makes sense, Jim. I guess the whole "market timing" and "dollar cost averaging" thing is so drilled into my head that the thought of suddenly putting a 5-figure amount into something all at once seems wrong somehow, but you point out why it isn't.

[snafu]

I too struggle with asset allocation. DCA-ing 'new' money as it is easier and let's me sleep without worrying if I did something dumb. I used to follow the age minus 100 theory I learned at my 1st finance management seminar.

Isn't adding to International Funds a timing thing? What are the circumstances in that region? Just now I'm watching what's happening in Ireland. Some countries [China] are so corrupt I have kept my position tiny and have designated buy & sell numbers like I do on equity 'stop loss.' I notice Americans have a nearly irrational fixation on taxes/tax consequences.

Like kork13, I use MM as a holding fund for sums not yet designated or 10 bagger profit, or short term savings to pay for an expensive purchase [plan to remodel 3 bthrms this summer] [China contract ends this week, yahoo].

I don't go to Macau or Las Vegas but take a flyer on a stock instead. Just now I'm debating selling off my position in a small Gold stock. I recovered my initial $ investment when gold hit $1K, scardy-cat that I am.

[jIM_Ohio]

That makes sense, Jim. I guess the whole "market timing" and "dollar cost averaging" thing is so drilled into my head that the thought of suddenly putting a 5-figure amount into something all at once seems wrong somehow, but you point out why it isn't.

I don't know how your portfolio is allocated... I am not moving 5 figures around when I rebalance anywhere (total portfolio for me is 200k, but most in one place is about 90k). I do take steps (like checking progress every 6 months) so I am rarely more than 3% off my targets- even if something runs up, I can usually catch it in time to change contributions to make sure the other assets are not falling behind.

[disneysteve]

Jim, what if you multiply that portfolio 10-fold (not that I'm there, but just speaking hypothetically). Now you've got a 2M portfolio and the most in one place is 900K. Rebalancing starts dealing with much larger numbers.

[Caoineag]

In my accounts, when I changed my allocation (switched from target fund that wasn't what I wanted to 2 funds that cover what I want), I just did an exchange. Obviously I am still dealing with small numbers but the allocation is what you are trying to maintain so you want to do it as quickly as possible. At least that is my thoughts on it.

[jIM_Ohio]

Jim, what if you multiply that portfolio 10-fold (not that I'm there, but just speaking hypothetically). Now you've got a 2M portfolio and the most in one place is 900K. Rebalancing starts dealing with much larger numbers.

Steve-
more than likely I would do quarterly tracking, or be invested more conservatively... if I had 2 M invested, I would probably have a 60% bond+cash position which makes buying easier.

and 90k in one place means 90k in my rollover at T Rowe, not 90k in one fund.

[disneysteve]

I'm probably just over-thinking this. I was just curious how others go about rebalancing. I'll keep doing the new money thing. If I get to a point where that isn't enough, then I'll just rebalance more frequently.

[scfr]

Having a balanced fund makes it easy ... I don't have to do anything to rebalance.

[jIM_Ohio]

I'm probably just over-thinking this. I was just curious how others go about rebalancing. I'll keep doing the new money thing. If I get to a point where that isn't enough, then I'll just rebalance more frequently.

Steve- I am going to make some SWAG's about you...

guessing you have around 300-500k invested
guessing your expenses are in 50k per year range and you contribute between 10-15k per year to retirement accounts.

Meaning you need about $2 M to retire, plus or minus, and are about 25% of the way there. More important than any of those numbers, guessing that you are about 80% equities in your investments.

Your portfolio with 80% equities is as volatile as it will ever be. As you approach retirement, your porfolio will be less volatile because you do not want to see 50% of it erased in 6 months- probably means you downgrade to 60% equities.

Reason I point this out is as people decrease equity exposure, the need to rebalance is both more important, and less likely to be because one asset is 10% off the target allocation because of a higher cash position.

Meaning if you are 80% equity, 15% bond and 5% cash now
and when you get closer to retirement you might change to
60% equity, 20% bonds and 20% cash.

That extra 15% cash is the key to rebalancing- you know that position will not "lose" money relative to equity position going down... (meaning if market tanks, you know cash position is not going to lose money) so the rebalance is moving cash which you have, by allocation, to equites (or bonds) based on poor performance of the other asset class.


Similar- when portfolio has the right amount of money (say $2M to retire on income of 80k per year), more than likely the allocation will be around 40% equites, 30% bonds and 30% cash (my allocation in retirement will probably be 40-60 or even less equity. The likelihood a person in this situation would be moving cash to equities in a 6 figure move (moving 100k from cash to equities is low) because of draw down strategies.

Which leads me to my point, I assume you are still in accumulation or growth phase...

1) starting out
means your deposits are higher than account balance, or your deposits are a significant (at least 5%) of your account balance.
2) accumulation.
means your deposits are higher than annual return (for example a $5000 annual Roth IRA deposit is higher in dollar amount than the annual return of your portfolio)
3) growth
means your deposits are a small fraction of your portfolio value. For example if you have $500,000 already invested and that money earns 5% ($25000) in one year, that $25,000 is worth more than the $5000 annual IRA deposit.
4) stability
means the growth of the porfolio is worth more than the income you have from a job. If you earn $40,000 per year and have $500,000 earning 9%, the portfolio is stable because it earned $45,000 while you earned $40,000.
5) draw down
means you have to sell shares because the stable portfolio does not provide enough income to you through annual gains. If you need $50,000 and your porfolio of $50,000 earning 9% only generates you $45,000, you need to sell shares so you have $50,000 in income for the year. The following year you only have $495,000 earning 9% and you will need to sell more each year to meet income needs.

Once a person hits stable phase, in my case my whole philosophy changes (hence 40-60 portfolio). When accumulating or growing, you might be off on allocation by 3-5% in any 6 month period (I find myself in that situation often). However once you add more fixed income, you lower the volatility to hopefully reduce how often the situation happens, and usually when it happens, you have enough cash to let market correct the rebalance without you moving money. I could not see myself retired and rebalancing (lowering cash position) with a portfolio like this:

$2M total
$800k equities
$600k bonds
$600k cash (this represents 10 years expenses)

If that 800k lost 50% (became 400k overnight) the 50% market drop lost 30% of my porfolio...

No way would I lower the cash position (rebalance) if I was living off the cash. No way.

My point is the larger porfolio will have less risk built in, and less need for rebalance.