Dieharder - Thanks for the explanation. That makes sense. It sounds like you re-balance based off of being over/short a certain percentage in your allocations, correct? Rather than just re-balancing every quarter-end, for example. I"m still trying to determine which path to go with. I personally like the idea of only rebalancing every quarter or semi-annually to reduce the tax implications and since I'm lazy.
That is correct. Major asset allocation such as stock / bond ratio will follow a 5% band. It works as follows:
stock / bond ratio 60/40 - you rebalance when stocks are at 65% or 55%
As I have found out over time, it takes extreme market moves to drop the asset allocation to this level. Last time I had to do this was in 2008 and last week is only the second instance in three years.
Under normal market conditions, even with new money going into cash, my AA rarely shift above 2% to 3% range between stocks / bonds.
I have found that this technique avoids re-balancing too frequently, and thus allows momentum to play out. It still does not capture the market bottom, if I were to modify this to a 10% band then I think I would have bought at the market low in 2009 and not late 2008 which was still early.
But that kind of market moves are rare, at least prior to 2008 and so far experienced this month. I think 5% band is reasonable to let you re-balance after capturing momentum effect, you may not catch the bottom, but the idea of re-balancing is never to do that.
The other thing I mentioned is instead of buying equity / bond in a fixed ratio with new contributions, I have decided to let all new contributions go into cash after 2009. Therefore I am not re-balancing when equities go up, only buying them when they go down because I am accumulating cash on the side while equities are going up. It's same as selling them and buying fixed income. Once equities fall, I use the accumulated cash to buy them.
It is easier to track the transactions and you can determine the purchase instead of your paycheck schedule deciding it for you.