Re-balancing question

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Lakeparty
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Re-balancing question

Post by Lakeparty » Sat Jun 17, 2017 9:18 pm

Hey guys super amateur question--- here it goes... but I get on a kick every now and then and peruse the forums and found something that talked about re-balancing can add about .35% to your portfolio if done once a year. Ever since I found this forum I decided to just buy Schwab's funds because I already had a Schwab account so when I have extra money I buy SCHB and SCHF. (US broad market ETF and International equity ETF)
I rather arbitrarily decided to buy about 80% SCHB and 20% SCHF but don't really have a hard fast rule to do so. I just buy whenever I have free money to put in.

1. Is the ratio really that important?

2. If you DO re-balance I know there are long term capital gains and short term capital gains but how do I know if I sell a portion of my ETF that it is going to sell the long term capital gains portion since its all in the same "pot".

3. I watched the great "beginner" videos and it talks about picking a day to do the re-balance. My ETFs will become long term capital gains precisely 365 days later? So I could pick my birthday for example and always do it? I guess leap year doesn't matter... You don't need to wait a year and a day or something like that?

Thanks for the help : )

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arcticpineapplecorp.
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Re: Re-balancing question

Post by arcticpineapplecorp. » Sat Jun 17, 2017 9:34 pm

Lakeparty wrote:Hey guys super amateur question--- here it goes... but I get on a kick every now and then and peruse the forums and found something that talked about re-balancing can add about .35% to your portfolio if done once a year. Ever since I found this forum I decided to just buy Schwab's funds because I already had a Schwab account so when I have extra money I buy SCHB and SCHF. (US broad market ETF and International equity ETF)
I rather arbitrarily decided to buy about 80% SCHB and 20% SCHF but don't really have a hard fast rule to do so. I just buy whenever I have free money to put in.

1. Is the ratio really that important?

2. If you DO re-balance I know there are long term capital gains and short term capital gains but how do I know if I sell a portion of my ETF that it is going to sell the long term capital gains portion since its all in the same "pot".

3. I watched the great "beginner" videos and it talks about picking a day to do the re-balance. My ETFs will become long term capital gains precisely 365 days later? So I could pick my birthday for example and always do it? I guess leap year doesn't matter... You don't need to wait a year and a day or something like that?

Thanks for the help : )
Assuming these funds are in a taxable account:

1. By ratio do you mean your holdings of 80% U.S. and 20% International (that's what schb and schf are for those of you wondering)? It depends on how much international you want. Bogle says 20% or less (down to 0%). Others like Swedroe, Merriman, etc. recommend closer to market cap weightings which would be closer to 50%. If you look at vanguard's total world stock market index fund it's 55% U.S. and 45% International:

https://personal.vanguard.com/us/funds/ ... IntExt=INT

Others go 70/30 U.S./International because previous research by Vanguard showed the sweet spot to be around there (or between 20-40%) for decreasing volatility. Of course Vanguard's own target date retirement funds used to be allocated that way, but in the past few years increased to 40% international. There's no one right answer as you can see. International carries currency risk. But lack of international carries country risk. You have to decide for yourself what you're comfortable with. Oh, is the amount important? No way to know until the game's over. In the past both U.S. and International have done about the same but there can be big differences between the two in any given year (like this year, or 2013 as examples. look it up).

2. check with schwab to see what order they use. Is it first in first out or some other way? The following link talks about different order of selling and discussing it with your custodian:
Choosing a method

You must tell your custodian (the brokerage or fund company which holds the assets) which accounting method to use. The brokerage can allow you to use a choice other than the standard choices, such as highest-in-first-out; if you use such a choice, you are effectively using specific identification, but giving a standing order to the brokerage, "Always sell the shares with the highest cost." (This option usually minimizes taxes, but you may need to override the decision to minimize taxes in some situations; for example, you might have a $2,000 short-term gain on the highest-cost shares and a $3,000 long-term gain on the lowest-cost shares.) source: https://www.bogleheads.org/wiki/Cost_basis_methods
3. Nerdwallet says:
To ensure your gain is the long-term type, pay close attention to the calendar when selling your assets. The holding period for a long-term capital gain is at least one year and a day. To reach that mark, begin counting on the date after the day you acquired the asset.

For example, if you bought stock on Jan. 10, 2017, and sell on the 10th day of the following January, your one-year ownership of the stock would mean your profit would be taxed at the higher short-term rate.

If you instead sell on Jan. 11, 2018 — 366 days since your purchase, since the day you dispose of the property is part of your holding period — it will net you the lower long-term capital gains tax rate. source: https://www.nerdwallet.com/blog/taxes/s ... tal-gains/
Welcome to the forum.
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

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siamond
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Re: Re-balancing question

Post by siamond » Sat Jun 17, 2017 10:17 pm

Lakeparty wrote:Hey guys super amateur question--- here it goes... but I get on a kick every now and then and peruse the forums and found something that talked about re-balancing can add about .35% to your portfolio if done once a year.
Can you provide a specific reference? Because this doesn't sound quite right, rebalancing gains are typically quite low, one would typically rebalance to stick to his/her plan, not really to eke out a meaningful gain. Although I'm not sure what you truly meant since you're not very specific about this "add about .35%" claim (add to what?).

As to your specific questions:
Lakeparty wrote:I rather arbitrarily decided to buy about 80% SCHB and 20% SCHF but don't really have a hard fast rule to do so. I just buy whenever I have free money to put in.
1. Is the ratio really that important?
Well, this is an asset allocation question, and actually one where opinions differ the most on this forum. You will never get a straight answer on this one, except for the fact that you should pick a ratio and then STICK TO IT. Don't change your mind every couple of years...
Lakeparty wrote:2. If you DO re-balance I know there are long term capital gains and short term capital gains but how do I know if I sell a portion of my ETF that it is going to sell the long term capital gains portion since its all in the same "pot".
Your broker will tell you. I am not familiar with Schwab's user interface, but there must be a way to display each individual lot (group of shares) that you purchased and when. And then you can easily figure out what is what.
Lakeparty wrote:3. I watched the great "beginner" videos and it talks about picking a day to do the re-balance. My ETFs will become long term capital gains precisely 365 days later? So I could pick my birthday for example and always do it? I guess leap year doesn't matter... You don't need to wait a year and a day or something like that?
The exact rebalancing details are surprisingly unimportant. Yes, doing it on your birthday is a fine idea, and it doesn't matter at all if there is an extra day every four years. And if you didn't stray much from your target after one year, don't bother rebalancing, better avoid being taxed for capital gains than trying to be more precise.

Now here is an important point: when you contribute some money, check the current status of your asset allocation. One of your two funds will be above target and the other will be below target. It is then a good idea to contribute the money to the 'below target' fund, e.g. "buy low". And this may very well be good enough for most years, leading you to a roughly balanced situation on the day of your birthday. Not always, mind you, but quite often. Again, those taxed capital gains are pesky...

Lakeparty
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Re: Re-balancing question

Post by Lakeparty » Sun Jun 18, 2017 12:53 am

siamond wrote:Can you provide a specific reference? Because this doesn't sound quite right, rebalancing gains are typically quite low, one would typically rebalance to stick to his/her plan, not really to eke out a meaningful gain. Although I'm not sure what you truly meant since you're not very specific about this "add about .35%" claim (add to what?).
The rebalancing gains I mentioned I read from http://www.investingadvicewatchdog.com/ ... ation.html --it was at the end of the page. "According to Vanguard rebalancing (to retain your bond/stock allocation ratio) can increase your returns at a rate of up to 0.35% annually."

I just thought it was interesting that it said you could see some extra return if you do rebalance yearly because I was planning on not bothering to rebalance except for adding new money to whichever of the two funds was low as everyone suggested. But if there is a possibility of some gains maybe it's worth doing once a year :D

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siamond
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Re: Re-balancing question

Post by siamond » Sun Jun 18, 2017 8:31 am

Here is the Vanguard paper: https://www.vanguard.com/pdf/ISGQVAA.pdf. It has been discussed many times on this forum, and although the various points they made are sound, their quantification is rather dubious, and especially for rebalancing. The best academic study on rebalancing is probably this article from Gobind Daryanani, which you may want to peruse. Multiple people on this forum (including myself) reproduced similar results while doing their own backtesting. Bottomline: rebalancing gains are very small, if any, and the exact rebalancing details do not matter much. BUT it is very important to rebalance for another much more powerful reason, to stick to your plan and strategy. As a side note, Vanguard recommends (and uses themselves in some funds) a 60/40 allocation between US and domestic nowadays, but again, opinions vary *wildly* about this topic.
Lakeparty wrote:I just thought it was interesting that it said you could see some extra return if you do rebalance yearly because I was planning on not bothering to rebalance except for adding new money to whichever of the two funds was low as everyone suggested. But if there is a possibility of some gains maybe it's worth doing once a year
Keep doing what you're doing, this is good, but do check your balances once a year. Sometimes stocks go out of whack and this will get unbalanced enough that it might be worth rebalancing. Maybe a rule of thumb for you to consider rebalancing would be a absolute variation of more than 5% on one of your positions. Still, be very wary of paying capital gains, this will erase any rebalancing 'bonus' in a hurry. If stocks drop a lot (e.g. during a crisis) and there would be no capital gain in rebalancing by using some recently acquired lots, by all means, do it. Otherwise... Maybe not.

Rebalancing is much easier in a tax-sheltered account (e.g. 401k, IRA, etc) than in a taxable account (which I assume is what you are speaking of here). This being said, why are all your savings going to a taxable account (that is, if my guess is correct)?

Lakeparty
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Re: Re-balancing question

Post by Lakeparty » Sun Jun 18, 2017 12:24 pm

siamond wrote:Rebalancing is much easier in a tax-sheltered account (e.g. 401k, IRA, etc) than in a taxable account (which I assume is what you are speaking of here). This being said, why are all your savings going to a taxable account (that is, if my guess is correct)?
I have some debt on my business still and it's property that takes up most of my money every year- the plan is to pay off the debt then invest more. It's not a terrible interest rate but the money I have borrowed is at 4.5% with the bank. But I still invest a small portion every year. So I put 5500 every year into an IRA and roll it to a Roth then everything else goes into a taxable account. I'm not sure what else I should be doing...

pkcrafter
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Re: Re-balancing question

Post by pkcrafter » Sun Jun 18, 2017 12:40 pm

I have some debt on my business
If you have a business, then you can set up a small business tax-deferred plan.

https://investor.vanguard.com/what-we-o ... pare-plans

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

Lakeparty
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Re: Re-balancing question

Post by Lakeparty » Sun Jun 18, 2017 12:47 pm

pkcrafter wrote:If you have a business, then you can set up a small business tax-deferred plan.
When I looked into a retirement plan for my office it seemed like it wasn't worth it after I had to pay to set it up, have some yearly fee and then have matching contributions for employees? It seemed like the reason to create a plan was to offer employees a nice benefit so they would be long term... but I already pay my employees well and give them a nice bonus so I don't do things like Health insurance or retirement plan. They appreciate the cash : )

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siamond
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Re: Re-balancing question

Post by siamond » Sun Jun 18, 2017 1:01 pm

Lakeparty wrote:
siamond wrote:Rebalancing is much easier in a tax-sheltered account (e.g. 401k, IRA, etc) than in a taxable account (which I assume is what you are speaking of here). This being said, why are all your savings going to a taxable account (that is, if my guess is correct)?
I have some debt on my business still and it's property that takes up most of my money every year- the plan is to pay off the debt then invest more. It's not a terrible interest rate but the money I have borrowed is at 4.5% with the bank. But I still invest a small portion every year. So I put 5500 every year into an IRA and roll it to a Roth then everything else goes into a taxable account. I'm not sure what else I should be doing...
Ok, then this should help you with the rebalancing (when needs be), by prioritizing changes in the tax-sheltered accounts (no tax impact, possibly no transaction costs either) while looking at the overall impact on your entire portfolio, and this might very well be good enough in most cases.

If you are operating a small business, then you should probably look at a SEP-IRA or a solo 401k or things like that. Plenty of material on this topic on the Bogleheads Wiki site. Good luck!

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