By Dr. James M. Dahle, WCI Founder
I thought it might be a good time to discuss a few things about rebalancing your investment portfolio such as the why, when, and how.
Why Rebalance Investment Accounts?
The whole point of the “know-nothing” fixed asset allocation approach to portfolio management is that you have no idea what is going to happen in the future. It is really a very liberating idea because it allows you to quit spending time on activities that do not add value to your portfolio. The idea is that you focus on the things you can control, like asset allocation, costs, tax management, and receiving the “market return,” and forget everything else. Basically, you set up your asset allocation to be something like this (and I'll use my parent's portfolio as an example):
- US Stocks 30%
- International Stocks 10%
- Small Value Stocks 5%
- REITs 5%
- TIPS 20%
- Intermediate Bonds 20%
- Short term Corporate Bonds 5%
- Cash 5%
Over any given period of time, one of these asset classes will do better than the others and conversely, one will do more poorly. I have no idea which except in retrospect. However, as the percentages change, the amount of risk the portfolio is taking on changes. For example, if stocks do great for 10 years and bonds do poorly, it is quite possible that instead of a 50/50 portfolio that this portfolio becomes 75/25. A 75/25 portfolio rises much quicker when the market goes up, but also crashes harder in a temporary or permanent (the real risk of investing) downturn.
Rebalancing Your Investments Gives the Investor 3 Things
#1 Risk Control
Returns the portfolio to the desired amount of risk.
#2 Rebalancing “Bonus”
Forces you to buy low and sell high, although in general, this one is a bit of a myth. Since most of the time “high-expected return” assets like stocks actually have higher returns, selling a high-expected return asset class and buying a low return asset class probably lowers overall returns, despite any “bonus” from buying low. However, the discipline it instills to buy something that hasn't been doing well does a lot for an investor's ability to stay the course.
#3 Something to Do
Many investors have a curious need to tinker with their portfolio. I literally only mess with my parents' portfolio twice a year. First, to rebalance and second, to take a Required Minimum Distribution (RMD) out of the portfolio. Frankly, you can do both at the same time if you like. Portfolio management can literally be that easy. It is honestly less than an hour a year. It costs them 9 basis points a year for the fund Expense Ratios (ERs) and has provided an annualized return from Mid-2006 through 2014 (through one big bear and one big bull) of 7.42% per year. My parents feel zero need to tinker, but many investors do, and at least this gives them something to do rather than make a behavioral investing mistake.
When to Rebalance Your Portfolio
There Are Really 2 Schools of Thought About Rebalancing
#1 Rebalancing Based on Time
The first is that you should rebalance based on time. Some people do it once a year, on the first of the year, on their birthday, when taking RMDs, or when making an annual contribution. The data shows that you probably should not do it any more frequently than once a year and that every 2-3 years is probably fine. That's not going to do much for the tinkerer, of course. My parents have done theirs in March when a contribution was made (which has made for some surprisingly fantastic accidental market timing by the way) for the last decade but we'll probably change to December soon when the RMDs are due since they are now fully retired.
However, if you're relatively early in the accumulation stage like I am, rebalancing once a year assumes that you're making relatively balanced contributions into your accounts. I'm not.
- I do Roth, HSA and 529 contributions in January
- 401(k) contributions monthly throughout the first half of the year
- Top-up individual 401(k) contributions and defined benefit plan contributions around tax-time
- Individual 401(k) and perhaps some taxable investing in the Fall
Given my multi-asset class portfolio and half a dozen investment accounts, it would be way too much of a pain (and cost) to contribute to every asset class every time I add money to the portfolio. So I tend to look at what's done poorly recently and rebalance with new contributions as I go along. For a young accumulating investor, it generally takes massive market movements for you to have a need to actually sell anything anyway.
Event focused rebalancing
#2 Event Focused
The second school of thought on rebalancing is that it should be event-focused. These folks tend to use rules like the 5/25 rule. That means if an asset class is “off” its target allocation by more than 5% absolute, or 25% relative, then you rebalance the entire portfolio immediately. So, to demonstrate how this works, let's look at my parents' portfolio.
| Asset Class | Target Allocation | Current Allocation |
| US Stocks | 30% | 34% |
| Intl Stocks | 10% | 13% |
| SV Stocks | 5% | 6% |
| REITs | 5% | 4% |
| TIPS | 20% | 17% |
| Int Bonds | 20% | 18% |
| ST Corporates | 5% | 4% |
| Cash | 5% | 4% |
Does the portfolio need to be rebalanced? Well, it's a little low on cash at 4%. But the difference between 5% and 4% is less than 5% absolute, and less than 25% relative (meaning 1.25% absolute for a 5% asset class.) The US stocks are a little high at 34%, but that's also both less than 5% absolute and 25% relative (meaning 7.5% for a 30% asset class.) However, international stocks are up to 13%. While that is less than 5% absolute, it is MORE than 25% relative (2.5% for a 10% asset class.) So it is time to rebalance the portfolio.
The downsides of an event-based rebalancing plan are #1 you have to look at your portfolio more than once a year and # 2 you might be rebalancing more frequently than is good for your portfolio. Sometimes, due to momentum, it actually helps to let the winners run for a little bit, which is why rebalancing no more often than once a year is probably a good idea.
How to Rebalance Your Investment Portfolio
So now you've determined that it is time to rebalance. How should you do it? Well, rebalancing doesn't make a HUGE difference, so it is very important that if you are going to do it that you minimize the costs of doing so lest the costs outweigh the benefits. Here are some tips to reduce costs:
#1 Rebalance the Whole Enchilada
It is generally not a good idea to have the exact same asset allocation in all your accounts. Thus, you don't want to rebalance your accounts individually. Consider it all one big portfolio (at least all accounts aimed at one goal, like retirement), and manage it that way.
#2 Make a Chart
Use a spreadsheet or other chart like the one above. You can even add a column showing the dollar amounts to buy and sell with minimal Excel knowledge. It might look like this:
| Portfolio Size | 1,005,208 | ||
| Asset Class | Target Allocation | Current Allocation | Amount to buy/sell |
| US Stocks | 30% | 34% | -$40,208 |
| Intl Stocks | 10% | 13% | -$30,156 |
| SV Stocks | 5% | 6% | -$10,052 |
| REITs | 5% | 4% | $10,052 |
| TIPS | 20% | 17% | $30,156 |
| Int Bonds | 20% | 18% | $20,104 |
| ST Corporates | 5% | 4% | $10,052 |
| Cash | 5% | 4% | $10,052 |
#3 Tax-Loss Harvest
If you have losses in a taxable account, tax-loss harvest them. $3,000 worth of losses can be taken against your regular income on your taxes each year and carried forward to future years. Plus, losses can be used to offset any gains you may have from rebalancing. In fact, you should be tax-loss harvesting any time you have a significant loss, not just when its time to rebalance.
#4 Use New Contributions
There is no cost to rebalancing with new contributions. So use them to rebalance as much as you can. In fact, if you are a beginning investor, it might be decades before you have to actually sell something to rebalance.
#5 Dividends/Capital Gains
If you avoid reinvesting your dividends and capital gains in a taxable account, those work just as well as new contributions.
#6 Beware Commissions
Depending on your strategy (mutual funds vs ETFs) there may be a commission and spread associated with buying and selling. Try to do your rebalancing in an account with no transaction costs. For example, a Vanguard Roth IRA invested in Vanguard mutual funds has no transaction costs, so it is a great place to rebalance.
#7 Taxes Are the Largest Transaction Costs
As a general rule, your largest transaction costs are taxes, so it is best to do your rebalancing inside 401(k)s, Roth IRAs, or other tax-protected accounts rather than a taxable account where it may generate capital gains. The goal is to rebalance for free. My portfolio would have to be REALLY out of whack before I actually paid money to rebalance it.
#8 Don't Pursue Perfection
I've become much more laissez-faire about rebalancing in the last few years. It just doesn't matter that much. Besides, the day after you rebalance your portfolio will just be “out-of-whack” again. So don't get worked up about it. For example, your portfolio might include 10% investment real estate that is particularly hard to rebalance due to liquidity issues and transaction costs. You just can't sell 6% of your apartment building. Either deal with it or simply add a similar, but more liquid investment (like a REIT index fund) to that particular asset class. Then you can do the rebalancing with the REIT fund. Is it perfect? No. Does it need to be? No.
Likewise, some 401(k)s (like the Federal TSP) make things tricky. They only let you rebalance the account based on percentages, not dollar amounts. That's fine if it's the only investment account you own. But if you're like me, you have to convert the percentage amounts to dollar amounts before putting in the transaction orders.
Also, keep in mind that buy/sell orders have to go in at different times of the day depending on the account. If you're using ETFs, they have to occur while the market is open. With the TSP, the deadline is noon Eastern. With Vanguard, the deadline is 4 pm Eastern (market close.) Although you don't need perfection, it's probably best to try to get all your buy/sell orders in on the same day when rebalancing.
#9 Take Advantage of Automation
If you're lucky enough (or unlucky enough) to only have a single investment account, then feel free to use an auto-rebalancing solution such as a Vanguard Target Retirement or Life Strategy fund. This works with multiple accounts also, as long as they all have that particular investment available. Just be aware if one of those accounts is taxable you may be giving up a little on the tax side to improve simplicity.
Still seem too complicated? Then hire an advisor. I list many low-cost ones here, even if the lowest-cost one can be found in your mirror each morning. If rebalancing seems too tough, actually putting the portfolio together in the first place will probably be overwhelming. The fewer the asset classes and the fewer the accounts, the easier portfolio management will be. You simply have to balance that ease of management against the possibly higher returns (and fun you'll get tinkering) from making things more complicated.
My rebalancing is ridiculously complicated with 11 asset classes and 11 accounts spread across the universe at Vanguard, Bridgeway, Lending Club, Prosper, Fidelity, TD Ameritrade, Schwab, HSA Bank, and the TSP. And that doesn't even include all the 529s. I actually have to do multiple Roth IRA transfers a year just to keep things reasonably balanced. I can completely understand someone hiring an investment manager to avoid dealing with all that. But it wasn't particularly complicated in the beginning, and just like learning to do your own taxes in residency only requires you to learn one or two new things every year, adding another asset class or account every now and then isn't that big a deal. Excel is your friend.
What do you think? Why do you rebalance your portfolio? When do you do it? How do you do it? Comment below!
well said Yearly is the standard from my readings
I see no reason to keep CASH in retirement plans as all assets are liquid
I do the same with my personal acct-NO CASH as I have some income and distributions from my ret plans
(This should be a comment but can’t figure out how to get an account!)
I recently read Bill Bernstein’s book “The Four Pillars of Investing” and he suggests that one should re-balance every 2-3 years. His rationale is that from historical data, best-performing and worst-performing asset classes tend to stay in their respective categories for around 2 years before reversing fortunes. One may risk losing out on potential continued growth of an asset by rebalancing too early (and conversely still be throwing funds into sinking ones that continue to sink for another year).
Curious to see what others’ experience are rebalancing q1yr vs less frequently as I am just starting with DIY investing…
My mental hangup with rebalancing is that once the floodgates are open and one abandons a simple strategy (one fund with a target date, three funds with a Bogleheads mix, etc.) then there’s evidence that portfolios more complex yet will offer marginally better returns based off of historical data. See Betterment’s complex portfolio, for instance:
https://www.betterment.com/portfolio/
The tedium of rebalancing scales at least linearly with the number of holdings, especially when changing incoming asset allocation is a task accomplished by filling out a PDF and emailing it to one’s employer’s benefits manager rather than checking a box on a website.
In a related piece of news, I see that Vanguard enabled its own robo-advisor service this year for accounts >$50k. They charge a relatively healthy 30 basis points in addition to underlying fund fees, however, and my data driven side wonders whether their recommend asset allocation would truly make up that fee:
http://www.investmentnews.com/article/20150505/FREE/150509967/vanguard-officially-launches-its-robo-adviser-drops-minimum
(The same argument goes for Betterment, of course, but they are more transparent about both their allocation recommendations and what they expect from them. I’d be using them for my tax-deferred accounts without a doubt were it not for the little snag that that’s not possible for those with employer-tied accounts.)
I would like to comment on “Rebalancing the Whole Enchilada” and treating all retirement accounts as one portfolio. I am 40 years old and hope to be able to retire at about 50. That leaves 9.5 years until I can access my retirement accounts for the most part without penalty. Therefore I’m treating my taxable account as an entirely separate retirement portfolio with a goal using this during my 50’s until I’m able to access my retirement accounts. Over the next 10 years I plan to shift this account more “conservative” while leaving my retirement accounts ‘fairly aggressive” bc they will not be used for at least 10 more years.
That’s fine, but keep in mind your overall performance still depends on your overall mix. Even if you wanted to keep aggressive stuff in taxable, you can always buy stocks in tax-protected to make up for selling them in taxable, keeping your overall mix the same. Same theory as those who keep their emergency fund in a tax-protected account while stocks are in taxable. If they need the E fund, they sell stocks in taxable and buy them with the emergency fund money. It’s all the same in the end.
I only have two retirement accounts. I rebalance my Roth every December and my 401K actually has a feature where it rebalances for you in January which is quite nice.
I hate auto rebalancing services when I have more than one account. That just screws things up if you’re trying to look at your portfolio all as one. Does your 401(k) allow you to turn that off if you don’t like it?
The Utah 529 automatically rebalances on the kid’s birthday. 4 kids = 4 different rebalancing dates. That’s a pain to keep track of.
Yes, you can turn off, or rebalance every 6 months or year. My Roth isn’t that impressive given I still don’t max a 401K so I don’t worry to much (plus I basically have the same categories in each or close to)
you consider 529 as part of the whole enchilada? I see the 529s for my kids as separate from my retirement plans.
I separate my asset allocations by goal. So since 529s are for college and retirement accounts are for retirement two separate asset allocations/investing plans.
In your example, I would not have rebalanced the whole portfolio just because one asset class was above target. I would have sold the international back to baseline, beefed up cash, and then put the remaining money into lower performing asset classes depending on where it was most cost effective to do so. I would have left US alone in your example. Just curious how others think about rebalancing…if it is typical to rejigger an entire portfolio just because one asset class hits target? I have never considered rebalancing in that way.
I think the best thing to do is decide on how you’re going to do it, write it down, and follow your plan. My point is that it really doesn’t matter exactly how you do it.
As I am retired and over 70, I withdraw from my investment accounts instead of adding to them. The withdrawals come in the form of RMDs from the IRAs and straight transfers from my taxable accounts, which I do only if I want extra cash beyond regular living expenses. About 60% of my investments are in Roths, which I have not touched. Over several years, I gradually converted from traditional IRAs to Roths, which reduced the RMD requirement. That said, I have no schedule for rebalancing. Although I occasionally switch investment vehicles when I perceive a fund or ETF is not performing up to expectations over a period of several years, I maintain about the same allocation plan that I set up seven or eight years ago. When a bit of rebalancing is appropriate, I do it in one of two ways: By selling the security or class that is overweight so that I can take my withdrawal, or 2) by reinvesting accrued dividends and interest. I am not manic about maintaining a strict balance. Right now, one particular fund has been outperforming for a few years, and is beyond the proportion I set as my normal limit for any one investment. But as long as it continues to do well, I probably will let it run.
I think it does matter from the point of view of reducing costs if you have taxable accounts. I would do it as described by Dr. Mom, as I have stocks in taxable, so do not want to generate more capital gains taxes than necessary to keep within 5/25.(i.e. I wouldn’t sell US and SV stocks.
I agree you should have a higher threshold to rebalance if there are costs involved.
With regard to higher rebalancing thresholds in taxable accounts, some authors recommend letting stocks drift up to 10% out of balance and only sell down to 5% above target in order to reduced triggering taxable gains. Would you do that, or just stick to the usual 5% threshold and sell 5%?
I would try very hard to NEVER trigger capital gains just to rebalance. The way to do that for most is to max out retirement accounts each year throughout their careers. The only people who probably can’t rebalance adequately within retirement accounts are those with a huge taxable to retirement account ratio.
I think I’m in this camp, with a tax-advantaged to taxable ratio of 1:1.
Could you do a blog post about how to rebalance allocations and keep assets sequestered in their tax efficient locations? A possible example, if I keep my 10% allocation of REITs in a tax-advantaged retirement account and my 30% allocation of Large Cap Growth funds in my taxable account (per usual advice) how do I rebalance these assets when the ratios skew? It seems to me, that if the REITs grow to 15%, I will have to sell 5% and then I’ll be left with cash in my tax-advantaged account, but I need to buy assets outside of that account….how?
Yes, I know a lot of rebalancing can be done solely with new contributions, but not all of it. And, how about rebalancing when no longer making contributions? If I’m withdrawing 4% or less annually and my allocations skew by much more than that in a normal volatility market, how do I maintain balance and tax efficiency? Thanks!
Every year it’s slightly different, but you can keep the general principles in mind. For example, if your allocation is 30% LCG and 10% REITS and 60% something else, and 50% of your portfolio is in tax-protected accounts, and you need to sell REITs to rebalance (since using new money to buy something else or selling REITs to fund RMDs or other portfolio withdrawals isn’t adequate) then you just sell them in the tax-protected account. You sell 5% of the portfolio invested in REITs, and buy 5% of the portfolio invested in something else. Not hard. You just have to look at it and figure out what’s the most tax-efficient way to rebalance.
General rules:
1) Rebalance first with new contributions or spending withdrawals
2) Rebalance next within a tax-protected account whenever possible
3) If you must rebalance in taxable, be sure you’re not reinvesting dividends. Use those to help you rebalance.
4) If you must rebalance in taxable, and must sell assets with a gain, make sure the gains are long-term and use the highest basis shares available.
5) Rebalancing can be done as infrequently as every 1-3 years with excellent results. There is usually no rush. The longer I invest, the less I worry about being precise about rebalancing. It’s just not a big deal. You just want to avoid having a dramatically different AA after a few years.
I have been thinking about the following section a lot recently:
“Rebalancing “bonus”– forces you to buy low and sell high, although in general, this one is a bit of a myth. Since most of the time “high-expected return” assets like stocks actually have higher returns, selling a high-expected return asset class and buying a low return asset class probably lowers overall returns, despite any “bonus” from buying low. However, the discipline it instills to buy something that hasn’t been doing well does a lot for an investors ability to stay the course.”
I am halfway through Bogle’s Common Sense book and he has mentioned don’t chase lower volatility at the expense of lower longer term growth several times. At this point since I am young I feel like just sticking with my 100% equities (small portfolio) and not having to worry about rebalancing for 4-5 years. I will be interested to see how I react to the next down market, but I am hoping that if I can stay aggressive and put 32k into Roth this year, that would set me up nicely 15-20 years down the road.
Hope that works out for you. It does for some, but not for others. Your income and savings rate matters more than anything in the beginning.
If you haven’t already, consider reading Ben Graham’s The Intelligent Investor next. I wish I had not been so intimidated by the idea of reading it when I was younger. It and Bogle’s Common Sense are two of my favorites.
I’ve read the first few chapters, but it was quite dense. I’ll try to pick it back up, but Bogle’s 3 book in 1 is clocking in at 2800 pages on the iPad. Probably be a few months until I get to read anything else.
I am quite interested in Bogle’s philosophy on International markets and his data on bond funds. Currently, I am thinking of 10% of money in “i” bonds 6-7 years from now and 90% Vanguard Total US Stock Market (my take on a Warren Buffett portfolio). I feel I would handle a downturn quite well, but won’t know until it happens again.
Buffet’s preface says to focus on Graham’s Chapters 8 and 20. I also liked 4 and 5. It is ok to cherry pick the ones you find most interesting. I liked the edition edited by Zweig who gives commentary on each chapter that simplifies them but is very insightful. Chapter 4 in particular gives some guidelines on who should/could consider a 100% stock portfolio. Happy reading!
I’m about 1/3 through that book, but am re-reading the Value Averaging Book your recommended. Found Value Averaging much easier to read. Maybe I’ll get back to the Intelligent Investor and ready those chapters first. It was all starting to feel like a textbook again, ugh.
I do agree with the 100% equity portfolio while “young.” You have an entire career to ride out bear markets. In fact, while young and beginning your investment portfolio, you should hope for a good bear market.
But, its easy to say you can mentally manage and accept marked decrease in equity values during a bear market, its quite another to actually be able to do it. Until you have actually experienced large market downturn, you will not know the emotions involved watching your all equity portfolio being decimated.
True. I know two older people who are 100% in equities and stayed strong throughout the 2008/09 downturn. Then again, they stayed strong because they are going for broke on their retirement. Probably a lot of sleepless nights.
WCI…What is your opinion of the different brokerages portfolio performance tracking tools? On the Bogelheads site, they seem to complain about Vanguards. I am pleased with Schwabs. I can enter outside holdings. I can look at my whole portfolio or just pieces. It is much easier and close enough for me as opposed to dealing with the whole separate spreadsheet on Excel. It also helped me realize when one of my few remaining active funds started messing around with gold and commodities which I was not interested in pursuing. So, I sold it and added to my index funds.
I’d be curious also as WCI uses so many different accounts. I have my 401K and Vanguard, so I find Vanguard pretty accurate to my spreadsheet, but it also has about 90% of my holdings, so I don’t add anything outside to it.
TSP, individual 401(k), partnership 401(k), his Roth IRA (spread across three custodians- Vanguard, Bridgeway, and Lending Club) and her Roth IRA, 529s for each kid and all the nieces and nephews, UGMA accounts for the kids, HSA etc etc etc
Why do I have so many? I guess I’d rather manage the complexity than pay more in taxes.
I haven’t used them. I’ve been using Excel for over a decade and haven’t seen any reason to change, especially given how many accounts I have. But if you like Schwab’s and can add outside accounts, why not do that?
Thanks WCI for the informative post. I just finished All About Asset Allocation by Rick Ferri. Highly recommend to other readers here- very much pertains to this article!
One of the first ones I read and still very useful. That information can be found elsewhere, but you need to get it from somewhere!
Question on Tax loss harvesting,
Thanks to this blog, I have taken charge of my wife’s and my finances. We are both newly graduated residents beginning our career. I am experiencing trouble due to multiple accounts, we both have Roth IRAs (now doing back door this year), a taxable account, and my wife begins her 401k (rolling over previous 403b), I am not eligible for 401k till next year.
I have goal of a simple portfolio (90% stock (all index funds) 10% bond allocation). To allow for tax loss harvesting I have chosen slightly different funds for taxable account, than in our roths or 401k. So taxable has Total Intl (Vanguard) and sp 500 index fund (vanguard), while the tax protected accounts have total us index (vanguard) and bonds. So I guess my only chance to tax loss harvest is if I experience loss on sp 500 or total international. Is it worth it to diversify more in taxable account? How often do you check for opportunities to harvest? Thanks in advance
You can pay Betterment to do it almost continuously. If I had a significant taxable account, I’d check it a month after I bought shares, 6 months after, a year after and maybe after that if there is a massive market correction. Remember there is no harvesting unless the share value is lower than you bought it for.
WCI,
I looked into betterment, but was concerned that because they will not have access to our roth and 401k that we may be subject to penalization if we use similar funds, creating a wash sale, especially since 401k and roth have automatic reinvesting of dividends. I could turn these off for the roths but not the 401k.
While I doubt you’ll get caught (nobody is actually looking that closely) the easy solution is using different funds in the two accounts. For example, Fidelity index funds in your Roth and Vanguard ones in taxable. Or 500 index in Roth and TSM in taxable etc.
So would selling VTIAX (Total Int Stock index) for fidelity’s FSIVX (Intl stock) to TLH be considerednot substantially identical. How do you know which index each tracks to tell? Thanks
I would consider those fair game, even if they tracked the same index. But you can find the index tracked in the prospectus.
Thanks, I will check the prospectus. By fair game do you mean they are not substantially identical, thus likely would not trigger the wash sale rule?
Yes, that’s what I mean. That said, it’s not me you have to defend it to. But I think that’s an easy defense in an audit.
Anyone recommend any of the many “robo-advisors” to help automate re-balancing?
WCI said, “It is generally not a good idea to have the exact same asset allocation in all your accounts.”
I assume you mean strategic placement of various expense ratios as well as where to place your bonds versus equities. I disagree. I have read the boglehead article espousing the complicated asset allocation between accounts. I did a mock trial for my accounts, and the benefits amounted to a couple of dollars. Even when assuming my account was $4,000,000, it only benefit me a couple of hundred dollars in decreased expense ratios. But, it cost me hours and hours pouring over a spreadsheet trying to get my asset allocation exactly right between my TD Ameritrade, Schwab, and John Hancock accounts. The best fund for each asset allocation within each account was also different, and threw the whole thing into disarray. Finally, the costs of purchasing and selling between all of those accounts ate up some money, too.
I found that the simplicity of having the exact same asset allocation in each account saves me many hours, especially with a straightforward 3 fund portfolio. To simplify even further, I haved 40% international, 40% US, and 20% bonds. If international and US are not closely the same number, then I know very quickly which one needs more money. Bonds should be 1/2 of that number. The hours I save more than make up for the meager benefits of being complicated.
I am on the other end. I find looking at all my accounts as a whole is easier. I have limited tax deferred space so all of my 401k and roth IRA is REITs. I can’t imaging how I would do my 10k roth IRA if I had to fit my 6 asset classes in it. But if you only have 3 funds and it doesn’t matter what is in taxable then keeping them all the same is the easiest. But, I think that most people aren’t that lucky.
Interesting! Good analysis. Surprised the benefit was so small in your particular situation. Simplicity brings its own benefits.
I would not make a big deal out of tax harvesting unless it is an account that you plan to leave to your heirs. The tax man recaptures your re-balancing gains when you sell your account. If you leave it to your heirs they get a step up in the basis and you win then. See Steve Evanson’s discussion on his website, http://www.evansonasset.com.
There’s still the time value of money, the ability to give appreciated shares to charity after booking a loss, and the possibility of being in a lower capital gains bracket later in life due to lower taxable income or change in brackets. I wouldn’t say it’s not worth doing.
I agree that you can avoid the recapture by donating appreciated shares. The possibility of being in a lower capital gains bracket latter in life due to a lower taxable income or a change in brackets is almost nil for physicians. See Richard Ferri’s article, Avoiding Taxes for Retirees is not Easy. I am retired and over 70 and 1/2 years of age and the increasing RMD guarantees that I will never be in a lower tax bracket. I believe the same holds for you and even younger physicians because all will have substantial deferred tax holdings unless they plan extraordinarily well. Furthermore, there is always the dangers that congress will recognize that our irresponsible deficit spending and free ride for the wealthy will have to come to an end at some point and when it is time to pay the piper, you know who will bear the brunt. You and me!!! Lastly, I don’t see how the time value of money figures into this discussion.
When you tax loss harvest, you save taxes now that you may not have to pay for thirty years. You get the use of that money for thirty years. There is value to that. Not to mention it is a nominal savings, not a real one.
So even if you don’t plan to give the asset to heirs, or to charity, and you don’t believe that you will be in a lower capital gains bracket due to personal wealth levels or governmental changes, there is a still a benefit, even if it may not be that large, to tax loss harvesting.
Point well taken. There is some value in time value of money, but for young investors, I doubt if it is worth much effort. It is of much more value for us old guys who plan to make charitable contributions with appreciated stock or mutual funds or plan to leave it to our heirs.
Sure, it might not make a BIG difference, but it’s so easy to do, why not?
I am new to investing and am trying to get started on my own so my questions will likely be more basic than most. Does the need to rebalance come from assets gained in a particular allocation? So if US stocks do well compared to bonds and I gain assets in stocks and now my total dollars invested are 75% stocks and 25% bonds rather than my intended 70/30 I would then rebalance back to 70% and 30%? I have a tenative plan to use 70% stocks (40% Vanguard Total Stock Market Fund and 30% Vanguard Total International Stock Market Fund) 30% bonds (15% Vanguard TIPS and 15% Vanguard Total Bond Fund). So then I would just redistribute the increase in assets back to my chosen asset allocation above?
That’s right.
Is it a good idea to rebalance after a huge downturn in the market, like we’ve seen the past two weeks? Isn’t that essentially trying to “time the market”? I understand the benefits of TLH and plan on doing so, but just not sure when it’s a good time to rebalance in this bear market. Currently I rebalance once a year with new contributions in January. Thanks for all you do – really enjoyed today’s post and I’m there with you on the front line.
You should follow your written financial plan. If it says rebalance on March 18th each year, then do it. If it says rebalance when your portfolio is off by a certain amount, and it is off that amount, then rebalance. If it doesn’t address when to rebalance, or you don’t have a plan at all, then get a plan that tells you when you will rebalance.
https://www.whitecoatinvestor.com/investing/you-need-an-investing-plan/
Hi Jim, I am expecting to make a big purchase in a couple years (don’t want to put aside money into my retirement account). Given the current state of the market, what would you suggest I do with my current cash reserve (hold it vs CD vs high interest saving account vs some magical formulation I am currently not privy to). Thanks for all you do.
While it may be tempting to put it in the stock market and “buy low” the truth is the stock market (and real estate) is for money you don’t need for 5-10+ years. This money belongs in a CD or high interest savings account. You can use a short term, high quality bond fund if you really want to reach for yield, but I probably wouldn’t.
Rebalance yearly or when you are off by 5% or more-think Swedroe feels that
I have investments in multiple locations. TransAmerica / Schwab (403b & 457b). His and her Vanguard Roth IRA. Vanguard taxable account. Four 529 accounts. And I’ve now started some real estate and other alternative investments.
I have an Excel document that looks at the overall combined portfolio (except the 529 accounts ). Typically, I was rebalancing annually. However, I now have more cash to invest in the Vanguard taxable account. Quarterly, I invest available cash in taxable account and accumulated dividends in tax protected accounts. I’m essentially rebalancing when I do this, buying what is low in my asset allocation.
For the 1st time, I’m TLH in taxable account and in the process rebalancing.
I separately rebalance the 529 accounts at time of annual purchase.
If the plan is to rebalance annually and with new contributions, then do that rather than coming up with a new rebalancing method now.
If there is notable inflation that occurs within the next 5 years, would that spur you to rebalance? Or do you presume that equities or whatever investments you have will have this (presumed) dollar value baked in?
Higher than expected inflation would not change my rebalancing plan, no.
Discipline and sticking to a plan…
I went through 2008 and learned that my risk tolerance was such that seeing my portfolio drop by 50% was not something I could tolerate well…intellectually yes but emotionally not so much.
I have stuck with 60/40 portfolio with too much cash and gold.
It has been difficult to rebalance into my bond funds over the last 11 years watching that money sit making a fraction of the s and p.
I lost over 7 figures with the corona crash but less then 15% of my net worth not counting real estate which will be hard to assess for some time.
I will now face the equally emotionally stressful rebalance of buying equities out of my bond, gold, and cash holdings as I can’t see equities doing well for at least a year but none of us can read the future.
I have read lots of posts about 90-100% equity portfolios and everyone is a expert when the market is on fire. Many were seduced by 11 year bull market into not really assessing their own risk tolerance.
The markets should eventually come back although this is a different shock then we have experienced before. I do not think applying a post 2008 expectation is appropriate as this is different as is our leadership. The world economy is different and lenient monetary policy is now paying the price for continuing to keep interest rates low to prop up an overinflated equity and real estate markets.
I hope everyone stays healthy and safe especially my colleagues who join me on the front line.
My strategy for rebalancing is to do it as infrequently as possible. I have been managing my portfolio (largely in tax-deferred accounts) for more than 20 years, and done the following:
Maintain a diversified portfolio. Over the past decade, I have seen, again and again, that sometimes foreign stock outperform US, bonds outperforming stocks, smalls outperforming large, and all vic e versa. So why rebalance? The market is often self-correcting. Although I have not always done as well as the S&P, which I consider my benchmark, I have achieved steady returns (until the last few weeks) with a minimum of stress.
I also watch the economy and the emotional state of the markets. I grew a bit dubious in 1999 and lightened up on equities; did the same in 2007. Months too early, but better that then late. Survived both with some cash to get back in when I felt it was time. For the past couple years, I have been getting more conservative, in keeping with my age, and moving more into bonds and, yes, cash. With interest rates dropping, the bonds have done much better than expected, though not keeping up with stocks until fairly recently. In the down market, of course, I’m losing plenty, but the bonds have been a cushion. My conclusion? The best insurance, if there is any, lies in healthy diversification, and I don’t mean gold or weird derivatives. I’ve lived through the terrible economic conditions around 1980, the dive of 1987, the burst of the dot-com bubble, and the recession of 2008-9. I rarely rebalance and rarely get heartburn.
When I rebalance my 403b (take out from one index and place it in another) even if there are dividends. Am I dinged for taxes or will be dinged for taxes? (Still many years from retirement/withdrawal.)
No taxes due when rebalancing in a 403b. Just be careful selling anything with a gain in a taxable account.
I’ve been fishing around for a study on how it’s best to handle new contributions. My 403b will only allow me to automate new contributions into a set allocation percentage of the available funds (ie. 50% VTSAX, 30% VTIAX, & 20% VBTLX contributed each pay period). My wife’s self directed 401k allows us to contribute new funds to whichever fund we like, but it’s not automatic. I have to check our holdings and chose the fund to invest every 2 weeks. I’ve always just applied the new contributions towards the underperforming fund in order to bring our allocation back in line with our investment targets.
Conventional wisdom seems to indicate that, during the earning years, rebalancing a portfolio to the desired allocation with new contributions is best. However, this strategy seems to take money away from any momentum in the market.
Has anyone read a study comparing historical outcomes of these two methods:
1. New contributions are always spread across your desired asset allocation regardless of performance (say 50% US equities, 30% Intl equities, and 20% bonds) and then periodically rebalanced?
2. New contributions go to the underperforming fund(s) in order to rebalance as you go?
Just curious, as I’ve read extensively and not been able to find the answer to this question.
I know there are studies that suggest the optimal rebalancing periods are 1-3 years, but I don’t know that they did exactly what you’re talking about.
I do # 2, but it’s entirely possible that #1 comes out ahead. If you’ve gotten to the point that this is your biggest concern, you’ve already won the game and shouldn’t worry about it!
How does one go about rebalancing with new contributions when you are not able to contribute to all your accounts? I have a new job and don’t have access to a tax-deferred/tax-free retirement account for 18 months. So for that period I will only be contributing to my taxable and roth IRA. If based on my asset location I only have total international and total US in those accounts, do I just invest in those according to my asset allocation plan, and then make up the difference once I gain access to my retirement account?
Asset classes gradually move from accounts you can’t contribute to toward accounts to which you can.