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.
What 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.
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.
How to Rebalance?
There are 2 main ways to bring your asset allocation back to your target.
- 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.
- 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. 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?
Personal Capital has a great suit of tools to analyze your portfolio and net worth for free. Sign up with Personal Capital if you don’t have an account with them yet.
photo credit: flickr tourist_on_earth
For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.
Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.
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