When to Rebalance and How to Rebalance Your Investment Portfolio

Here are some thoughts from the wonderful book The Bogleheads' Guide to Investing (I LOVED the book -- see my rating for details) on when to rebalance and how to rebalance your investment portfolio. (Note: see What is Investment Rebalancing and Why You Need to Do It in case you're wondering why this is important.) First, their thoughts on when to rebalance:

You're probably going to read and hear a number of opinions on when you should rebalance. [But] you need to consider two factors: costs and taxes. Costs would include any commissions and fees incurred by trading. Taxes would be a factor if the rebalancing takes place in a taxable account because you may realize taxable gains.

The most common method of rebalancing is based on time. The typical time frame is either quarterly, semiannually, or annually. However, Morningstar found that investors who rebalanced their investments at 18-month intervals reaped many of the same benefits as those who rebalanced more often, but with less costs. Another advantage of the Morningstar method in a taxable account is that you're assured of having long-term capital gains, since you've held the fund longer than 12 months.

They go on to say that there's a second method based on percentages -- keeping a certain percentage in each class of investments you have. It's a detailed explanation, so see the book if you want more information on it.

I've mentioned before that I'm in the midst of rebalancing my portfolio, but because of capital gains I've amassed through the years, it's taking me some time.

As far as rebalancing and reviewing my investment plan, I develop an annual plan, implement it throughout the year, and check in quarterly to see how I'm doing.

Next, the book tackles the issue of how to rebalance your portfolio. It's a four-step process that's a bit too long to share here, but the basics are selling the overweighted investments and reinvesting into the underweighted ones. (Duh, huh?) ;-)

The book also lists nine tips to consider when rebalancing as well as some final thoughts on the issue before the chapter ends. For those of you who want more details, see chapter 17 of the book.

Comments

[Brian]

Great info. However, I found it confusing to rebalance based on asset class. I found it easier to understand the asset class(es) of each of the mutual funds in my retirement accounts. You can then decide what percentage of each of your mutual funds you want in your portfolio. It was easier for me to see how things are changing over time in this way. But, you must be careful to make sure the mutual fund's investment strategy (i.e. how the fund is diversified in different asset classes) doesn't change over time.

And I agree, The Boglehead's Guide to Investing is a great book that I am currently reading, thanks to your rating, FMF!

[Kim]

I've found one of the easier ways to rebalance my investments is to just change where I put my new investments so everything stays in balance.

So if I invest in 2 funds and start with 50% in each, with ongoing investments going 50% into each, over time, if Fund A grows much faster than Fund B, Fund A will be more than 50% of my portfolio.

Instead of selling part of Fund A and moving it to Fund B, and potentially creating expenses and taxable events, I change my automatic investments to send more than 50% to Fund B and less to Fund A. Over time they'll even back out and I'll readjust my ongoing contributions.

If you are adding to your investments on a regular basis (semi-monthly, etc), this strategy can work great. Plus, if you believe in the long term strength of your funds, you are really buying more of fund B when the price is low and less of fund A when the price is high. Win-win.