determining a proper asset allocation<\/a> and regularly rebalancing, the investor \u2014 not the market \u2014 determines the level of risk in the portfolio.<\/p>\nTrue or false? True … usually<\/i>.<\/b> Rebalancing can move you out of highfliers poised for a fall. The degree to which that reduces your risk depends on what you’re rebalancing your portfolio into. Which brings us to our next point …<\/p>\n
True or False: The Stock-Bond Split Is Key?<\/b><\/i>
\nIf the investments in your portfolio tend to move together in the same direction and to similar degrees, rebalancing is less useful. Conversely, when those holdings don’t move in lockstep, rebalancing does a better job at managing risk.<\/p>\n
In the investment world, that lockstep is known as correlation \u2014 the degree to which assets perform similarly in any given year. Broad categories of stocks \u2014 e.g.<\/i>, large caps and small caps, or U.S. stocks and European stocks \u2014 are at least somewhat correlated, often highly so. Stocks and bonds, on the other hand, are only mildly correlated, and most importantly, bonds tend to smell rosy when stocks stink. Thus, if the biggest reason to rebalance is to control risk (which is usually done by investing in bonds), then the most important allocation to monitor and rebalance is your stock-bond split.<\/p>\n
Let’s return to our example portfolio but remove the bonds, instead adding 10% to large caps, small caps, and international stocks, and 5% to REITs. The results: The non-rebalanced portfolio posts an annualized return of 11.3% (turning $100,000 into $5,785,943), whereas the rebalanced portfolio returns an annualized 11.5% (ending with $6,328,103). Once again, we see a rebalancing bonus of 0.2% a year.<\/p>\n
However, on the risk-reduction front, rebalancing added nada<\/i>. Both portfolios experienced seven years of declines of similar degrees. The three worst calendar-year declines for the non-rebalanced portfolio were 38.1%, 23.2%, and 18.2%, and the three worst for the rebalanced portfolio were 38.6%, 23.0%, and 18.7%. The rebalanced portfolio earned higher returns in the 1970s, 1980s, and \u2014 interestingly \u2014 the 1990s. However, the bond-free rebalanced portfolio slightly trailed the bond-free non-rebalanced portfolio in the 2000s \u2014 the decade when risk reduction was needed most.<\/p>\n
True or false? In general, true.<\/i><\/b> Ensuring the right split between stocks and bonds can lower your risk of sharp declines \u2014 and of running out of money in the future.<\/p>\n
Tips for Rebalancing<\/b><\/i>
\nEnough theory! Here are some practical considerations when it comes to rearranging your portfolio.<\/p>\n\n- \n
\n- Account for taxes and other costs.<\/b> If rebalancing results in big commissions or tax bills, the potential boost to returns could easily disappear. Whenever possible, rebalance in tax-advantaged accounts \u2014 such as IRAs or 401(k)s \u2014 and keep costs low by limiting transactions to no-load funds and discount brokerages. That said, don’t let the tax tail wag the investment dog. Plenty of people held onto stocks in the 1990s just because they didn’t want to pay the capital gains taxes. The market took care of that for them \u2014 by significantly reducing or eliminating the gains.<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n
<\/p>\n
\n- \n
\n- Rebalance with contributions and withdrawals.<\/b> You can gradually rebalance your portfolio with strategic inflows and outflows. If you’re still working, use savings to buy more of underweighted assets (those that take up less of your portfolio than current market conditions warrant); retirees, on the other hand, should sell what’s become overweighted. An analysis by asset manager and author Phil DeMuth found that selling what has performed the best over the past year could prolong the life of a portfolio.<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n
<\/p>\n
\n- Rebalance annually \u2014 at most.<\/b> Rebalancing more than once a year (e.g.<\/i>, monthly or quarterly) is more trouble than it’s worth. You’ll spend more in time, costs, and taxes to get a lower return. In technical terms, such behavior is known as “silly.” In fact, you’ll likely realize slightly higher returns and lower transaction costs if you rebalance even less frequently than annually \u2014 perhaps every two to three years. For example, you could rebalance once an asset class reaches a certain level \u2014 such as being 20% below your target allocation, or 20% beyond it. Thus, if your goal is that a certain asset make up 10% of your portfolio, you’d rebalance once that asset declined to less than 8% or grew beyond 12%.<\/li>\n<\/ul>\n
In the end, it’s most important that you choose the strategy you’ll really do<\/b>. For ease of implementation, it’s hard to beat annual rebalancing. As asset manager Rick Ferri wrote in All About Asset Allocation<\/i>:<\/p>\nWhat is best for you is [a plan] you will actually maintain without procrastination. Annual rebalancing is simple and cost-effective, and it takes only a little time each year to implement, which means that you are more likely to get it done.<\/p><\/blockquote>\n
J.D.’s note:<\/b><\/i> I had intended to tackle re-balancing myself next week, but Robert beat me to it. That’s okay. He knows more about it anyhow. Instead, I’ll chronicle the process as I try to rebalance my own portfolio.<\/div>\n <\/p>\n","protected":false},"excerpt":{"rendered":"
How would you like $4,290,387? It’s easy! Just go back to 1972 and invest $100,000 into a well-diversified portfolio. Not enough money for you? Well, then, here’s how you can add $334,124 to that tidy sum: Simply rebalance this well-diversified portfolio annually.<\/p>\n
Okay, despite my fondness for Marty McFly, there’s no way to travel back 38 years and open a brokerage account. But the past few decades may provide clues about the next few, especially regarding portfolio behavior and the value of rebalancing. Below, we’ll look at three common beliefs about rebalancing and explain whether they’re true or false \u2014 and why.<\/p>\n
Reduce, Reuse … Rebalance?<\/b><\/i>
\nIn case you’re new to the concept, rebalancing is the process of returning a portfolio to an investor’s predetermined appropriate allocation (for example, 65% stocks and 35% bonds). A balanced portfolio is key to ensuring steady, growing returns<\/b>, but the movement of various investments over time can cause that initial, balanced allocation to change; assets that have done well become a bigger piece of the pie, while the laggards shrink to a smaller portion.<\/\n<\/p>\n","protected":false},"author":1422,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":[],"categories":[492],"acf":[],"_links":{"self":[{"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/posts\/79672"}],"collection":[{"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/users\/1422"}],"replies":[{"embeddable":true,"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/comments?post=79672"}],"version-history":[{"count":0,"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/posts\/79672\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/media?parent=79672"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.getrichslowly.org\/wp-json\/wp\/v2\/categories?post=79672"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}