Rebalancing via contributions

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dvd7e
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Rebalancing via contributions

Post by dvd7e »

Hello,

I've read that rebalancing too frequently can be detrimental to performance. I'm wondering if the same logic applies if I'm rebalancing via contributions.

I have a 401k that I'm primarily contributing to, and an IRA which I can't contribute nearly as much to. I have taken the "Portfolio 3" approach from the Bogle heads wiki (https://www.bogleheads.org/wiki/Asset_a ... e_accounts) where I've picked the best funds available as opposed to going with each fund in each account. But because my 401k balance is much larger than my IRA, and because my 401k doesn't contain all the funds that I own collectively, it doesn't seem like I can use constant contribution percentages now and forever more. I'm thinking that I may need to adjust my contribution %'s every few months in order to keep things in rough alignment. It seems to me like it's kinda-almost-sorta like continuous reblanancing. Is there any detriment to readjusting contribution percentages every few months as a means for rebalancing, or is that too frequent?
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CABob
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Re: Rebalancing via contributions

Post by CABob »

I don't see any problem with rebalancing in the manner you have described. There may be an issue of momentum gains by not rebalancing too soon, but, adjusting your contributions every few months should never be a problem. I would think that would be preferable to any other method given the circumstances you describe.
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Toons
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Re: Rebalancing via contributions

Post by Toons »

Rebalancing gradually with new contributions is a method I have practiced over the years and it has worked just fine.
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
rkhusky
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Re: Rebalancing via contributions

Post by rkhusky »

dvd7e wrote: I've read that rebalancing too frequently can be detrimental to performance.
There is nothing wrong with rebalancing frequently, especially in a tax advantaged account. Balanced funds and target date funds probably rebalance daily.
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grabiner
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Re: Rebalancing via contributions

Post by grabiner »

Rebalancing has the same effect on performance whether you do it via contributions or exchanges.

For example, suppose that you buy $60K in stock and $40K in bonds. The stock market rises, and you now have $75K in stock and $40K in bonds, an allocation of 65% stock. If you don't rebalance, your returns will be the returns of a 65% stock allocation. If you rebalance by investing $10K of new money in bonds (getting to $75K/$50K) or by selling $9K of stock (getting to $69K/46K), you will have a 60% allocation again. This will decrease your expected returns (since stocks tend to outperform bonds) but also decrease your risk (which is the reason you might want to do it).
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Aptenodytes
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Re: Rebalancing via contributions

Post by Aptenodytes »

If you believe in the value of postponing relabancing then you should be using new contributions to accentuate your imabalance. Not to do so is illogical and inconsistent. For example, if your portfolio drifts from 60% stocks to 65% stocks, and you believe that it would be a mistake to rebalance to 60% stocks, then the new money should go to stocks, not bonds.

This is perfectly obvious, for the reasons Grabiner points out. Yet many people like to believe in hidden powers of money coming from different locations.
basspond
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Re: Rebalancing via contributions

Post by basspond »

Adjusting contributions has also worked great for me. To me rebalancing by selling one class of assets to buy another is similar to trying to time the market. I believe in rebalancing but doing it over time in small steps and accepting a range of up to 15% variance in your preferred allocations. When I retire I plan to rebalance by adjusting where my distributions are taken from.
dbr
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Re: Rebalancing via contributions

Post by dbr »

basspond wrote:Adjusting contributions has also worked great for me. To me rebalancing by selling one class of assets to buy another is similar to trying to time the market. I believe in rebalancing but doing it over time in small steps and accepting a range of up to 15% variance in your preferred allocations. When I retire I plan to rebalance by adjusting where my distributions are taken from.
As long as money is coming in or going out it is certainly helpful to direct those funds so as to push the asset allocation to target, or keep it there. Most people would do that. If this is not enough to keep things within a predetermined range of the plan, then selling and buying is appropriate. There is no market timing involved.
basspond
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Re: Rebalancing via contributions

Post by basspond »

dbr wrote:There is no market timing involved.
I have to disagree. Rebalancing by selling/buying is based on a point in time when one asset class has out or under performed another, than selling one to buy another in hopes that from that point forward they will maintain their same percentage values. Then what happens if the values reverse then you are selling the one you just bought and buying the other you just sold.
dbr
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Re: Rebalancing via contributions

Post by dbr »

basspond wrote:
dbr wrote:There is no market timing involved.
I have to disagree. Rebalancing by selling/buying is based on a point in time when one asset class has out or under performed another, than selling one to buy another in hopes that from that point forward they will maintain their same percentage values. Then what happens if the values reverse then you are selling the one you just bought and buying the other you just sold.
That is not what people usually mean by market timing.
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dvd7e
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Re: Rebalancing via contributions

Post by dvd7e »

Does anyone know of any good tools that will figure out what contribution %'s to use to continually seek your ideal asset allocation across accounts? (Other than breaking out an excel spreadsheet and manually doing it every pay period)
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Aptenodytes
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Re: Rebalancing via contributions

Post by Aptenodytes »

dvd7e wrote:Does anyone know of any good tools that will figure out what contribution %'s to use to continually seek your ideal asset allocation across accounts? (Other than breaking out an excel spreadsheet and manually doing it every pay period)
Don't aim for precision. Just put the money in any low fund.
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ERMD
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Re: Rebalancing via contributions

Post by ERMD »

dbr wrote:
basspond wrote:
dbr wrote:There is no market timing involved.
I have to disagree. Rebalancing by selling/buying is based on a point in time when one asset class has out or under performed another, than selling one to buy another in hopes that from that point forward they will maintain their same percentage values. Then what happens if the values reverse then you are selling the one you just bought and buying the other you just sold.
That is not what people usually mean by market timing.
"t's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing." -- livesoft
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grabiner
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Re: Rebalancing via contributions

Post by grabiner »

basspond wrote:
dbr wrote:There is no market timing involved.
I have to disagree. Rebalancing by selling/buying is based on a point in time when one asset class has out or under performed another, than selling one to buy another in hopes that from that point forward they will maintain their same percentage values. Then what happens if the values reverse then you are selling the one you just bought and buying the other you just sold.
I would view rebalancing as avoiding market timing. If you want 70% of your stock to be US and 30% foreign, you believe that this is the optimal division. If a falling dollar and Japanese market boom cause your stock to become 60% US and 40% foreign, and you still believe that 70% foreign is appropriate, you need to buy more US stock (either with new money, or by selling foreign stock if you don't have new money). If you let your allocation stay, you imply that you now believe 60/40 is better, or at least that you don't care.

And rebalancing between stocks and bonds is primarily about risk control. If you hold 60% stock, and a rising stock market and falling bond market move your portfolio to 70% stock, you may have no idea how stocks and bonds will perform, but you know that a 70% stock portfolio is riskier than a 60% stock portfolio. Selling stock allows you to reduce that risk.
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Aptenodytes
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Re: Rebalancing via contributions

Post by Aptenodytes »

grabiner wrote:
basspond wrote:
dbr wrote:There is no market timing involved.
I have to disagree. Rebalancing by selling/buying is based on a point in time when one asset class has out or under performed another, than selling one to buy another in hopes that from that point forward they will maintain their same percentage values. Then what happens if the values reverse then you are selling the one you just bought and buying the other you just sold.
I would view rebalancing as avoiding market timing. If you want 70% of your stock to be US and 30% foreign, you believe that this is the optimal division. If a falling dollar and Japanese market boom cause your stock to become 60% US and 40% foreign, and you still believe that 70% foreign is appropriate, you need to buy more US stock (either with new money, or by selling foreign stock if you don't have new money). If you let your allocation stay, you imply that you now believe 60/40 is better, or at least that you don't care.

And rebalancing between stocks and bonds is primarily about risk control. If you hold 60% stock, and a rising stock market and falling bond market move your portfolio to 70% stock, you may have no idea how stocks and bonds will perform, but you know that a 70% stock portfolio is riskier than a 60% stock portfolio. Selling stock allows you to reduce that risk.
The long arc of rebalancing maintains your desired risk and diversification characteristics. We all agree with that. If you believe that the oscillations around that arc have some predictability to them (i.e. you believe in actionable momentum) then you can time your rebalancing moves to try to eke out a few basis points over the constant-rebalancing scenario. E.g. if stocks have moved down and you are out of balance, but you believe stocks are likely to continue to fall, you may choose to put off rebalancing for a while. If you don't believe in actionable momentum, then you don't bother trying to time your rebalance moves.
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beyou
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Re: Rebalancing via contributions

Post by beyou »

I too have followed what I think you describe, for many years.
I pick a fund or two that is best/most appropriate for each account,
(401k vs IRA vs taxable) and buy to rebalance (when a fund is low).

Good strategy for accumulation, and when the markets are moving gradually.
There will be times when contributions alone wont maintain your AA, and you will
have to consider an extra fund in one of your accounts.
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I Palindrome I
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Re: Rebalancing via contributions

Post by I Palindrome I »

Aptenodytes wrote:
dvd7e wrote:Does anyone know of any good tools that will figure out what contribution %'s to use to continually seek your ideal asset allocation across accounts? (Other than breaking out an excel spreadsheet and manually doing it every pay period)
Don't aim for precision. Just put the money in any low fund.
Not a useful approach for me, nor, I suspect, others. For my workplace savings, I log into Fidelity and fill in a webform that lets me specify what percent of new contributions should go to each fund per account. Money gets added out of every paycheck, every two weeks, so if I just semi-arbitrarily overweight the contributions to any low fund, I'm likely to end up off track again pretty quickly. Plus I don't want to change the contribution instructions every two weeks (and I think there's a limit to the number of times I can do that per year, anyway).

I think I'm in a roughly similar situation to dvd7e, and recently figured out how to allocate new contributions when you have multiple accounts that are funded unevenly. I'm moving from a mirrored allocations approach (from that linked page) to a spread allocation approach. Been meaning to post the following as sort of an FYI, then saw this thread, and thought I'd add it here.

Here's a simple, notional target allocation (not my real target, just a useful example):
Tot Stk Mkt (TSM) 50%
Tot Bnd Mkt (TBM) 30%
Int Stk Mkt (ISM) 20%

Here's a set of retirement accounts across which I'm trying to maintain this allocation (actually pretty close to my actual situation):
401A 27% of current portfolio total balance
403B 61%
Roth IRA 12%

It's pretty easy to spread the allocation across the accounts, at a single point in time:
TSM in 401A 27% of total (100% of 401A)
TSM in 403B 23% of total (37% of 403B)
TBM in 403B 30% of total (49% of 403B)
ISM in 403B 8% of total (13% of 403B)
ISM in Roth IRA 12% of total (100% of IRA)

The problem comes with adjusting my ongoing contributions to maintain this allocation. Because of the way my workplace matching is structured and the amount I can typically afford to add to the Roth IRA, these are my typical contribution percentages (how much of all retirement contributions land in each account per year):
401A 30%
403B 57%
Roth IRA 13%

Ignoring market performance, just having contributions percentages that don't match the account size percentages means that things will get out of whack sooner or later. Therefore, don't base the contribution percentages on the current account distribution (27/61/12), but rather on the distribution of new money (30/57/13).

TSM in 401A 30% of new contribs
TSM in 403B 20% of new contribs (35% of 403B contrib)
TBM in 403B 30% of new contribs (53% of 403B contribs)
ISM in 403B 7% of new contribs (12% of 403B contribs)
ISM in Roth IRA 13% (100% of IRA contribs)

This all feels like it's complicated, but once you have a spreadsheet set up it's almost trivial. And while the difference in contribution amounts are relatively small between the approaches above, you might as well get it right.

Be aware, though, that this approach only works when your current allocation is close enough to your target that you don't care. That's the situation I'll be in when I finish rebalancing from mirrored to spread allocation. Once market performance starts to have an impact you'll need to start using actual account-fund values for current, target, and contribution (as opposed to percentages--if there's a way to do it with just percentages I haven't figured it out yet) to calculate corrective contributions, and probably recalculating twice a year. I could post that later but it's not quite as simple as the above, and I fear I've run on long enough for now.
scottyja
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Re: Rebalancing via contributions

Post by scottyja »

dvd7e wrote:Does anyone know of any good tools that will figure out what contribution %'s to use to continually seek your ideal asset allocation across accounts? (Other than breaking out an excel spreadsheet and manually doing it every pay period)
I use the 'Optimal lazy portfolio rebalancing calculator' (http://optimalrebalancing.tk/). It's very basic, but has worked well for my HSA, which doesn't provide any auto-rebalancing.
Last edited by scottyja on Thu Jan 29, 2015 12:57 pm, edited 1 time in total.
fposte
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Re: Rebalancing via contributions

Post by fposte »

aaronb wrote:
Aptenodytes wrote: Don't aim for precision. Just put the money in any low fund.
Not a useful approach for me, nor, I suspect, others. For my workplace savings, I log into Fidelity and fill in a webform that lets me specify what percent of new contributions should go to each fund per account. Money gets added out of every paycheck, every two weeks, so if I just semi-arbitrarily overweight the contributions to any low fund, I'm likely to end up off track again pretty quickly. Plus I don't want to change the contribution instructions every two weeks (and I think there's a limit to the number of times I can do that per year, anyway).
Mine's with Fidelity as well, and I don't have any problem changing the contribution amount whenever I please. And while it's not technically the same thing as rebalancing via contribution, you can always move money from one fund to another after contributing if you'd rather do that (so long as you don't fall afoul of frequency rules). I think the interface makes this really easy; I'm surprised to hear it's an obstacle for some.
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I Palindrome I
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Re: Rebalancing via contributions

Post by I Palindrome I »

fposte wrote: Mine's with Fidelity as well, and I don't have any problem changing the contribution amount whenever I please. And while it's not technically the same thing as rebalancing via contribution, you can always move money from one fund to another after contributing if you'd rather do that (so long as you don't fall afoul of frequency rules). I think the interface makes this really easy; I'm surprised to hear it's an obstacle for some.
I just checked our Retirement Program Handbook, and we can change the way future contributions get invested at any time. Among Fidelity Funds, we can transfer "Any time except from International funds, which are limited to four times per year".

So I was completely mistaken about limits on how often I can change things. I'd still rather change the contributions infrequently rather than per-paycheck.
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