Previous post:

Next post:

Early Retirement Investing 101: Rebalance Your Portfolio

by retirebyforty on October 4, 2013 · 30 comments

in early retirement guide, investing

We all know that figuring out our Asset Allocation is essential for long term investing. If you don’t know what I’m talking about, then you need to read last week’s article (linked above.) Unfortunately, the work is not done even when you have the ideal asset allocation for your age, risk tolerance, and goals. In a volatile stock and bond markets, your asset allocation will inevitably deviate from your target. You need to remember to check your asset allocation and rebalance once in a while.

rebalance asset allocation early retirement investingWhat is rebalancing?

Rebalancing is a strategy to bring your current asset allocation back in line with your target allocation.

When to rebalance?

Generally, you don’t want to rebalance too often simply because of the transaction fees.

  • Rebalance once a year. This is the easiest way to rebalance. Just check once a year on your birthday (or another easy to remember date) to see if your portfolio needs to be rebalanced.
  • Rebalance when your asset allocation deviates 5% from your target. You need to keep a closer eye on your asset allocation with this strategy, but you still shouldn’t have to rebalance very often with this.

Why rebalance?

Let’s look at the most basic level first. For example, your asset allocation is set to 60/40 (stock/bonds*) at the beginning of 2013. The stock market did very well this year and the bond market took a beating. By October 1st, your asset allocation would be 65/35. This is a little bit out of line with your target asset allocation and rebalancing will bring them back on target. I’m assuming no additional investment in this example. Why rebalance when the stock market is doing so well? Rebalancing will force you to sell high and buy low. Isn’t that the goal of investing? You’ll take some profit on the stock market gain and get a good deal on bonds when you rebalance. Note – I used Vanguard’s VTSMX (total stock market index) and VBTLX (total bond market index) for this example. early retirement investing rebalance your portfolio asset allocation

How to Rebalance?

There are 2 main ways to bring your asset allocation back to your target.

  1. Sell some winners and buy on the cheap. In the example above, you’d sell some VTSMX and buy VBTLX. This is easy because you can bring your asset allocation back to target in one shot.
  2. Reallocate your saving/contribution. This one assumes you are still adding to your investment every month. In this case, you can just buy bonds instead of stocks with any additional investment. Eventually, your asset allocation will get back on target. The advantage here is you won’t have to pay as much transaction fee, but it could take a while to rebalance this way.

In the past, I stuck with #2 and modified the mix of new contributions. However, once our portfolio grows bigger, then it’s harder to change the % much with new investment. Now that I have quit my engineering career, I also can’t invest as much, so a new contribution has even less impact.

Rebalance across your entire Net Worth

It’s important to rebalance across your entire portfolio. Most of us have a mix of 401(k), IRA, Roth IRA, taxable account, CDs, 529, HSA, bonds, and bank accounts. Add your spouse’s accounts and it becomes quite difficult to keep track of your household’s asset allocation. It’s good to take advantage of these tax advantage accounts, but this makes rebalancing quite unwieldy. I have an Excel spreadsheet to keep track of all our accounts, but it takes time and effort to maintain. Last year I signed up with Personal Capital and keeping track of my asset allocation got much easier. I linked all my investment and bank accounts in Personal Capital and I can see my current asset allocation whenever I log on. early retirement investing rebalance stock bond market asset allocation This dynamic chart makes it much easier to keep track of our asset allocation. You can click through the US Stocks section to see how your stock is allocated by capitalization and value as well. (If you have an account already, you can get here by going to Investing > Portfolio > Allocation.) Unfortunately, we can’t specify our target asset allocation in Personal Capital right now. The target allocation in the screenshot is just their recommendation. I still have my target asset allocation in my old Excel spreadsheet.

RB40 rebalance in 2013

Recently, I updated our target asset allocation. We allocated around 10% to cash last year because we wanted to be prepared for the worst case scenario. It turned out that we didn’t need all that cash so now I’m changing cash to 5% and investing the other 5%. Here is my current asset allocation target

  • Cash 5%
  • Bonds 20%
  • Stocks 65%
  • Alternatives 10% (I have Peer to peer lending, REITs, and precious metals here.)

I’m going to open an individual 401(k) account and contribute $20,000. Then I’ll probably put the rest into our dividend portfolio to increase our dividend income. How is your asset allocation doing?  When was the last time you rebalanced your portfolio? rebalance your portfolio control finance asset allocation photo credit: flickr tourist_on_earth

{ 30 comments… read them below or add one }

[email protected] October 4, 2013 at 1:13 am

I rebalance once a year my funds, but since I have a pension I am 90% in stocks. In a few years I plan to lower that allocation towards bonds. Hopefully interest rates will be higher.

Reply

retirebyforty October 4, 2013 at 9:01 am

Wow, 90% is high. How old are you? I used to be almost 100% in stock, but now I need some bonds.

Reply

Srini P October 6, 2013 at 3:03 pm

Mr. RB40, I thought your 20% allocation is high. I have less than 10% (I am 36). Isn’t it going to be a tough few year stretch for Bonds?

Reply

retirebyforty October 6, 2013 at 6:00 pm

You don’t have to care how stock or bond do in the short term if you rebalance periodically. You just need to be comfortable with your target asset allocation. This depends more on your risk (volatility) tolerance and age.
A tough few years for bonds is a good chance to pick them up for cheap. When the next stock market crash happens, you’ll be able to sell the bonds and buy stock.

Reply

Srini October 7, 2013 at 7:42 am

Thanks!

sendaiben October 4, 2013 at 4:13 am

Your allocation target above adds up to 110%…

Commendably enthusiastic, but ;)

Reply

Dining on Dividends October 4, 2013 at 8:21 am

sendaiben – Hmmm, in my world 1% + 5% + 86% + 8% + 0% = 100%, not 110%.
Lets hope you have not been overestimating your returns!! :)

Reply

Dining on Dividends October 4, 2013 at 8:27 am

sendaiben – I now see you were referring to his current asset allocation (110%) and not his target (100%). I shall now go in the corner and keep quiet… :(

Reply

retirebyforty October 4, 2013 at 9:06 am

Sorry, my mistake too. :)

Reply

retirebyforty October 4, 2013 at 9:01 am

I blame my editor. :)

Reply

EL @ Moneywatch101 October 4, 2013 at 6:11 am

I rebalance twice a year and I have done both options selling some of the winners to buy the losers and adding new contributions to the cheaper options. Personal Capital sounds like a great time saver.

Reply

retirebyforty October 4, 2013 at 9:01 am

Personal Capital is great. I really like them and it’s free!

Reply

Done by Forty October 4, 2013 at 6:41 am

I’ve been avoiding our first rebalance but this year, we’ll do it. I think I’ll probably go with method #1 just to be done with it, & I don’t think there should be many (any?) transaction fees with the index funds we use.

Reply

retirebyforty October 4, 2013 at 9:02 am

Have fun! :) I have a hard time diving in and paying for all that transactions too.

Reply

moneystepper October 4, 2013 at 7:07 am

I tend to rebalance once or twice a year, and have just recently done so, effectively putting more money into our real estate investments.

Quick point to note, your split adds to 110%. Quite a risky balance, some might say… :)

Reply

retirebyforty October 4, 2013 at 9:03 am

Do you put real estate in the alternative category?

Reply

Pretired Nick October 4, 2013 at 7:38 am

Do you consider your rental property to be in alternatives or other? I guess you could say I’m in the process of rebalancing since I’m migrating rental money to other investments. To me the hardest part of this is deciding what percentage should be in which bucket.

Reply

retirebyforty October 4, 2013 at 9:04 am

No, I just put rental properties off by themselves. I don’t count them here.
Try personal Capital’s financial advisor. I’m sure you qualify for a free analysis.
Everyone I talked to liked the analysis. Or maybe talk to a local guy.

Reply

Insourcelife October 4, 2013 at 8:32 am

All excellent points in this post. For us, re-balancing is not really an issue currently. Our entire retirement portfolio is in Vanguard 2040 and there is no need to do anything since it automatically adjusts. Our taxable portfolio is in stocks, bonds and REITs. Since I just started that portfolio it will be small enough for the foreseeable future to use the second re-balancing method you mentioned – using new investments to fine tune the allocation between the 3 ETFs. I can’t wait until re-balancing becomes an issue since it would mean that our taxable portfolio grew to a nice large sum where monthly contributions are not enough to bring the allocation back in balance.

Reply

retirebyforty October 4, 2013 at 9:07 am

That’s a great way to do it too. Great job! I like Vanguard’s target date funds. They make life much easier.

Reply

Dominic October 5, 2013 at 8:39 am

How can we open individual 401(k) account? Are you mean IRA? If we put more than $5,000 into IRA account, I don’t think it deductible.

Reply

retirebyforty October 5, 2013 at 9:05 am

You need to be self employed or be a business owner to open an individual 401(k) account. I will write about my experience with Vanguard soon. I’m in the process of opening one now. You can contribute up to $51,000 of earned income. That’s a lot of tax write off.

Reply

Venkatesh November 28, 2013 at 11:48 pm

Are you classifying yourself as self employed or as a business owner? I thought you were stay at home dad. I am confused.

From Vanguard’s page https://investor.vanguard.com/what-we-offer/small-business/individual-401k:

Participants Sole proprietors or partners who have no
common-law employees.
Employer contributions The lesser of up to 25% of the compensation* or, for 2013, $51,000. The dollar figure must be reduced by any employee deferrals made to the plan. Deductible as a business expense and not required every year.

Reply

retirebyforty November 29, 2013 at 9:26 am

I’m a stay at home dad who is self employed.
Not really sure what your point is here. I make some money from my website and I can contribute to the individual 401(k). I already talked to Vanguard about this and will write a follow up soon.

Reply

Bryce @ Save and Conquer October 5, 2013 at 1:49 pm

We rebalance once a year on my birthday. We also try to maintain our target allocation by placing new funds into the asset that is currently underweighted.

Reply

Untemplater October 6, 2013 at 10:16 pm

I try to rebalance about once a quarter or whenever there is a huge market swing. Since I don’t always watch the market that closely, I have a calendar reminder to check and login to my retirement accounts. I’ll look at my performance and decide if I want to rebalance or not.

Reply

retirebyforty October 7, 2013 at 10:58 am

Rebalancing when there is a big market swing is a great idea. I should try that too.

Reply

Justin @ RootofGood October 6, 2013 at 11:43 pm

I seem to rebalance when I’m bored. It’s probably about that time again, since I haven’t taken a look at the asset allocations vs targets for over a month. And it is usually less “rebalance” and more “where to put new money”. Aiming for targets in my asset allocation means the money gets invested in the asset classes that have performed the worst recently (buying low!!).

Reply

Mike October 7, 2013 at 12:52 am

Which company are you using to maintain this fund (and is the fund an IRA or other retirement account)? I am getting ready to get started on funding an IRA in the near future since I am approaching 26 (maybe a little too old, but I am also focusing on having incomes that are not dependent on a job as well so maybe I can make the lack of retirement planning up elsewhere…).

Reply

retirebyforty October 7, 2013 at 11:01 am

I’m with a few brokerage actually. Next year I will try to consolidate them into one or two accounts.
I like Firstrade. That’s where I have my Roth IRA and dividend stocks. http://retireby40.org/2013/01/start-contributing-roth-ira/
Good luck! 26 is still young, you just need to get going. :)

Reply

Leave a Comment