Rebalancing Limitations

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Topic Author
rhythm
Posts: 9
Joined: Sun Nov 18, 2018 7:24 am

Rebalancing Limitations

Post by rhythm » Sun Oct 06, 2019 4:40 pm

Hi all,

I have two questions on rebalancing.

I've read the wiki article (https://www.bogleheads.org/wiki/Rebalancing) and also the chapter about it in "The Bogleheads guide to investing" (Great book by the way!)

Here lie my four funds and current percentage allocation:

Fund A - 26.27%
Fund B - 26.21%
Fund C - 23.94%
Fund D - 23.58%

And I'd like to rebalance to:

Fund A - 25.00%
Fund B - 25.00%
Fund C - 25.00%
Fund D - 25.00%

My only option to rebalance on the providers website is to allocate new percentages to each fund, totaling 100.00%.
Is it even possible for me to ensure that I am selling from funds A and B to buy into funds C and D?

Which brings me to the last question.
What are the advantages / disadvantages of:

Option 1 - Rebalancing by selling the better performing funds to top up the worse performing funds?
Option 2 - Rebalancing by adding money to the worse performing funds?

My mind tells me option 1 is better as you are taking advantage of both the better and worst performing funds to lock in a gain essentially.

The account is tax-advantaged.


Thanks for your help!

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vineviz
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Re: Rebalancing Limitations

Post by vineviz » Sun Oct 06, 2019 4:49 pm

rhythm wrote:
Sun Oct 06, 2019 4:40 pm
My only option to rebalance on the providers website is to allocate new percentages to each fund, totaling 100.00%.
Is it even possible for me to ensure that I am selling from funds A and B to buy into funds C and D?
Yes, in fact if you enter 25% for each fund there is no way to accomplish that EXCEPT to sell from funds A and B.

rhythm wrote:
Sun Oct 06, 2019 4:40 pm
What are the advantages / disadvantages of:

Option 1 - Rebalancing by selling the better performing funds to top up the worse performing funds?
Option 2 - Rebalancing by adding money to the worse performing funds?
If you were going to add money to the account anyway, these options are identical in the final result. You take a different path, but you end up in the same place. Otherwise, the advantage of Option 2 is that your account will grow faster because of additional contributions.

And for what it's worth, I suggest that it's generally not useful to rebalance when the funds are within +/- 5% of their target allocation. In other words, I wouldn't bother with a manual rebalancing until one of the funds was more than 30% or less than 20% of the portfolio.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Topic Author
rhythm
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Re: Rebalancing Limitations

Post by rhythm » Sun Oct 06, 2019 5:06 pm

vineviz wrote:
Sun Oct 06, 2019 4:49 pm
rhythm wrote:
Sun Oct 06, 2019 4:40 pm
My only option to rebalance on the providers website is to allocate new percentages to each fund, totaling 100.00%.
Is it even possible for me to ensure that I am selling from funds A and B to buy into funds C and D?
Yes, in fact if you enter 25% for each fund there is no way to accomplish that EXCEPT to sell from funds A and B.
Thanks vineviz.

Hrmm OK, I think perhaps because I can't see what math they use in the backend, I wonder how exactly they process it.
For example, I could imagine that they use fund D to top up fund C and then fund A and B to top up fund D. Can this change the end result? I guess like you are saying I think, it would all become relative anyway?

vineviz wrote:
Sun Oct 06, 2019 4:49 pm
rhythm wrote:
Sun Oct 06, 2019 4:40 pm
What are the advantages / disadvantages of:

Option 1 - Rebalancing by selling the better performing funds to top up the worse performing funds?
Option 2 - Rebalancing by adding money to the worse performing funds?

If you were going to add money to the account anyway, these options are identical in the final result. You take a different path, but you end up in the same place. Otherwise, the advantage of Option 2 is that your account will grow faster because of additional contributions.

And for what it's worth, I suggest that it's generally not useful to rebalance when the funds are within +/- 5% of their target allocation. In other words, I wouldn't bother with a manual rebalancing until one of the funds was more than 30% or less than 20% of the portfolio.
I can't understand how the two different approaches end up with the same result. I'm not saying I don't believe you, just can't get my head around it right now. If you have any books or reading you can suggest, please share.

You make a good point with the +/- 5% allocation rule, I'd like to follow this. Getting prepared when I hit the threshold :)

rkhusky
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Re: Rebalancing Limitations

Post by rkhusky » Sun Oct 06, 2019 5:57 pm

If you end up at the same point, it doesn’t matter how it got there (unless it takes a week to process). You have to sell 1.27% of A and 1.21% of B and buy 1.06% of C and 1.42% of D. Doesn’t matter if A or B funds C. Money from A and B lose their identity once sold.

Rebalance and then add 1/4 of contribution to each fund. Or add all of the contribution to Fund A and then rebalance. Ends up the same.

If rebalancing is as easy as typing 25 a few times and clicking “go”, rebalance as often as you want.

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vineviz
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Re: Rebalancing Limitations

Post by vineviz » Sun Oct 06, 2019 7:26 pm

rhythm wrote:
Sun Oct 06, 2019 5:06 pm
I can't understand how the two different approaches end up with the same result. I'm not saying I don't believe you, just can't get my head around it right now. If you have any books or reading you can suggest, please share.
If you end up with the same allocation (i.e. 25% in each of four funds), then it really can't make much difference how you get there. Right?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Ferdinand2014
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Re: Rebalancing Limitations

Post by Ferdinand2014 » Sun Oct 06, 2019 7:40 pm

Option 2 is essentially the same as option 1, except as your balance becomes much larger then your contribution over time will take longer to rebalance to your target. Under most circumstances this will be a very small difference relative to option 1. I prefer option 2 myself only because I like to visualize my unrealized gains over the years (exchanging to another fund causes the proportional unrealized gain percent to reset to zero in my Fidelity accounts) and I also have my bi-weekly contributions on automatic investments both in taxable and tax deferred which keeps my hands off tinkering.
Last edited by Ferdinand2014 on Mon Oct 07, 2019 12:39 am, edited 1 time in total.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

MotoTrojan
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Re: Rebalancing Limitations

Post by MotoTrojan » Sun Oct 06, 2019 8:14 pm

How else could you get C and D to 25% without selling from A and B? In tax-advantaged it’s all the same. You could put all your contribution into A, then rebalance moments later (no price change) and what do you get? The same 25/25/25/25. Similarly if you rebalance then immediately add contributions at 25/25/25/25 you’ll be at the same place if you had just used the contributions to get to balance (assuming they were sufficiently large).

In taxable there would be a cost to selling A and B, thus it’s better to try and maintain balance via only contributions.

Topic Author
rhythm
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Joined: Sun Nov 18, 2018 7:24 am

Re: Rebalancing Limitations

Post by rhythm » Mon Oct 07, 2019 4:05 am

Thanks all for your responses, appreciate it.
Making more sense I think...

One last scenario to see what your comments would be :)

As an example, let's say that I have this allocation:

Fund A = 50.00% - Equity
Fund B = 50.00% - Bonds

A week later, equities boom and the allocation is now:

Fund A = 90.00% - Equity
Fund B = 10.00% - Bonds

Would you rebalance by selling fund A and buying fund B, or would buy more of fund B?
And why?

I think I know the answer, but would like to hear what you have to say.


Thanks.

rkhusky
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Re: Rebalancing Limitations

Post by rkhusky » Mon Oct 07, 2019 6:56 am

rhythm wrote:
Mon Oct 07, 2019 4:05 am
As an example, let's say that I have this allocation:

Fund A = 50.00% - Equity
Fund B = 50.00% - Bonds

A week later, equities boom and the allocation is now:

Fund A = 90.00% - Equity
Fund B = 10.00% - Bonds

Would you rebalance by selling fund A and buying fund B, or would buy more of fund B?
And why?
Whatever brings me back to 50/50, because that is my desired asset allocation. I could buy more B with outside money, but if that didn't bring the allocation to 50/50, I would also sell A to buy B. If I didn't have outside money, then it would be all selling A to buy B.

Note: If bonds stayed the same, stocks would have to go up by 800% in order for the AA to go from 50/50 to 90/10. That's some boom.

nolesrule
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Re: Rebalancing Limitations

Post by nolesrule » Mon Oct 07, 2019 7:26 am

Is this hypothetical? Because the allocations in the first post haven't drifted enough for me to consider rebalancing. I would just continue contributing at my designated asset allocation percentages on autopilot. Maybe if we're talking contributions to an account where I controlled selecting the asset at the time of contribution, such as an IRA or a taxable account, I might just buy more of the low allocations, but if it was an employer account where you make elections I'd just let it ride.

Topic Author
rhythm
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Joined: Sun Nov 18, 2018 7:24 am

Re: Rebalancing Limitations

Post by rhythm » Mon Oct 07, 2019 7:46 am

Thanks nolesrule and rkhusky,

Yes it is hypothetical.

I have it stuck in my head that selling a better performing fund to top up a worse performing fund has to yield a higher total return than adding to the worse performing fund to get the allocation in line.

I can't explain why, but it seems to be a bias I have. Selling high and buying low.
You've all said it doesn't matter which I am listening too and will act upon.

Ferdinand2014
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Re: Rebalancing Limitations

Post by Ferdinand2014 » Mon Oct 07, 2019 10:43 am

rhythm wrote:
Mon Oct 07, 2019 7:46 am
Thanks nolesrule and rkhusky,

Yes it is hypothetical.

I have it stuck in my head that selling a better performing fund to top up a worse performing fund has to yield a higher total return than adding to the worse performing fund to get the allocation in line.

I can't explain why, but it seems to be a bias I have. Selling high and buying low.
You've all said it doesn't matter which I am listening too and will act upon.
Sometimes that is true and sometimes it isn't true. If the better performing fund continues to rise in value over say the next 6 months than you will have decreased year total return. The opposite could be true as well. You do not rebalance to increase total return. You rebalance to improve risk adjusted return. In fact not rebalancing would likely increase total long-term returns. However your volatility and risk would increase over time.
“You only find out who is swimming naked when the tide goes out.“ — Warren Buffett

Topic Author
rhythm
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Joined: Sun Nov 18, 2018 7:24 am

Re: Rebalancing Limitations

Post by rhythm » Mon Oct 07, 2019 2:37 pm

Ferdinand2014 wrote:
Mon Oct 07, 2019 10:43 am
rhythm wrote:
Mon Oct 07, 2019 7:46 am
Thanks nolesrule and rkhusky,

Yes it is hypothetical.

I have it stuck in my head that selling a better performing fund to top up a worse performing fund has to yield a higher total return than adding to the worse performing fund to get the allocation in line.

I can't explain why, but it seems to be a bias I have. Selling high and buying low.
You've all said it doesn't matter which I am listening too and will act upon.
Sometimes that is true and sometimes it isn't true. If the better performing fund continues to rise in value over say the next 6 months than you will have decreased year total return. The opposite could be true as well. You do not rebalance to increase total return. You rebalance to improve risk adjusted return. In fact not rebalancing would likely increase total long-term returns. However your volatility and risk would increase over time.
Wow, that is just what I needed to read Ferdinand2014.
That makes sense and I understand.

Thank you.

retired@50
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Re: Rebalancing Limitations

Post by retired@50 » Wed Oct 09, 2019 11:44 pm

rhythm wrote:
Mon Oct 07, 2019 7:46 am
Thanks nolesrule and rkhusky,

Yes it is hypothetical.

I have it stuck in my head that selling a better performing fund to top up a worse performing fund has to yield a higher total return than adding to the worse performing fund to get the allocation in line.

I can't explain why, but it seems to be a bias I have. Selling high and buying low.
You've all said it doesn't matter which I am listening too and will act upon.
To me, the course of action you take might possibly depend on what phase of life you're in and what account type (taxable or tax deferred). If you're still contributing (still working), you can add money to the lower performing funds as discussed, or you can sell the winners and buy the losers. If it were a 401k that I was still contributing to, I'd sell the winners and buy the losers. I'd choose this course of action so I wouldn't have to adjust my contribution percentages, then adjust them back again later after the shortfall had been made up. I'd rather just set and forget. If it's a taxable account, then you'd have to consider the tax implications of any selling that you'll do. Of course if you are retired, and withdrawing, you'd just pull money from the winners and leave it at that, no need to buy the losers. Regards,

MotoTrojan
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Joined: Wed Feb 01, 2017 8:39 pm

Re: Rebalancing Limitations

Post by MotoTrojan » Wed Oct 09, 2019 11:52 pm

rhythm wrote:
Mon Oct 07, 2019 7:46 am
Thanks nolesrule and rkhusky,

Yes it is hypothetical.

I have it stuck in my head that selling a better performing fund to top up a worse performing fund has to yield a higher total return than adding to the worse performing fund to get the allocation in line.

I can't explain why, but it seems to be a bias I have. Selling high and buying low.
You've all said it doesn't matter which I am listening too and will act upon.
Think about it. You have $50 in fund A, $50 in fund B. Fund A triples to $150. You want to get back to 50/50, but are also investing another $100 that same day.

Option 1: Put $100 into Fund B, end up with $150 each.

Option 2: Move $50 from A to B, balancing yourself at $100 each, then add $50 to each to end at the same point.

Do you see how these are equivalent in a Roth? In taxable you paid tax to sell A in Option 2, so that would be a bad decision.

Many people use dividends and contributions to maintain balance for ease and also to avoid selling for gains in taxable.

Topic Author
rhythm
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Joined: Sun Nov 18, 2018 7:24 am

Re: Rebalancing Limitations

Post by rhythm » Thu Oct 10, 2019 6:37 am

Thanks retired@50 and MotoTrojan.

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