ramsfan wrote:Rick - thanks for the great thread and advice for us all. I am sure you have commented on this before, but what is your recommended approach for rebalancing? Thanks!
Rebalancing can be done in two ways; by calendar or by bands (percentages).
Calendar rebalancing is done by choosing a time period and rebalancing when the calendar tells you too, such as quarterly, annually or semi-annually. Rebalancing by bands requires you to compare your fixed target asset allocation against your current allocation and rebalance those investments that fall outside target bands, such as + or - 10% of the allocation.
Calendar rebalancing is easy because you only need to look at your allocations once per year or every other year depending on selected period for rebalancing. Band rebalancing requires considerably more time because you are measuring asset classes daily, weekly or at least monthly and making shifts as needed. In either case, I also suggest doing a rebalancing when you deposit money or withdraw money.
So, which is better? I will answer that two ways; from a self-managed individual investors standpoint and from a optimal portfolio management standpoint.
From a self-managed individual investors standpoint, MOST people should use the calendar method. That is the simplest method, and more important, it stops people from constantly monitoring their portfolio which will prevent many cognitive mistakes such as trying to time markets, trying to move in and out of sectors, and panic selling in very bad downturns.
From an optimal portfolio management standpoint, bands are better. They capture volatility in between periods rather than at random points at the end of periods. For example, the S&P 500 was up 5.1% in 1987, so a calendar rebalancing method would not have done any rebalancing that year. But the stock market was up more than 20% in the summer and down more than 20% in the fall. A band rebalancing method would have sold stocks in the summer ad bought them in the fall. The difference was an extra 1% return for band rebalancing over doing it at the end of the year.
In summary, calendar rebalancing is much easier to implement and maintain, and get you 90% of the benefit of band rebalancing. Thus, for casual do-it-yourself individual investors, I highly recommend calendar rebalancing.