Best Method/Way to Rebalance Portfolio?

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AndromedaAsc
Posts: 20
Joined: Thu Oct 01, 2009 11:08 pm

Best Method/Way to Rebalance Portfolio?

Post by AndromedaAsc »

I've been through the Boglehead Wiki and Guide, but I can't seem to find any good write up on rebalancing. Can anyone point me to some good detailed resources?

Here's what I've figured out:

Considerations to note when rebalancing:
1) Selling will incur some capital gains tax... the amount depends on your tax bracket. I think this might be best avoided if possible.
2) It may be difficult to rebalance monies between IRA and taxable accounts, as you can't pull your IRA out. Also, if you're just starting out, chances will be that your IRA has a small sum which may complicate matters as some index funds have a relatively high min sum to open.

Several methods I thought of:

Method 1
Rebalance every year, 6-mth or 3-mth depending on how much you can save. Accumulate the savings in some money market fund, then do a lump-sum investment at regular intervals. How much to invest in which category depends on the state of one's portfolio. For e.g. in a bull market one will invest more in bonds than it stocks and vice versa for bear markets. The larger sum you accumulate before each regular lump sum investment, the better as the cost associated with broker fees or load mutual funds will be less. However, if one accumulates too much money in money market, there can be an "opportunity" cost as it is not invested in equity/bonds that may yield higher returns. I think this plan best advantage is that there is no selling involved, so one will never need to worry about taxes.

Method 2
Do a monthly savings plan into all your investment instruments based on your asset allocation. Every 3mth or 6mth, check your portfolio to see if you are overweight or underweight in any category and adjust accordingly. For e.g. for a 70/30 equity/bonds, one would invest say $700 in stocks and $300 in bonds monthly. 6mths later assume that the ratio has grown to 60/40. To rebalance one would change the investment to $500 stocks and $500 bonds until the target portfolio ratio is met. Using this method there is no "opportunity" cost as all savings are placed into equity/bonds instantly. However, the manual adjustment of monthly savings plan may be a bit tedious. Also, there is no selling here, so one does not need to worry about taxes.

Method 3
A monthly savings plan based on your asset allocation. Stick to it and don't change the monthly plans. Perhaps what would be the most obvious method too. When a particular asset is overweighted, sell it and buy into the assets that are underweighted. However, taxes may be incured in taxable accounts. I also forsee problem if you would like to sell your equity funds (taxable) and buy bond funds (IRA) but if your IRA limit is reached then you might have some complications. The reverse scenario may be problematic as well since one cannot withdraw money from IRA easily.

What do fellow Bogleheads think?
Tramper Al
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Joined: Thu Oct 18, 2007 11:42 am

Post by Tramper Al »

Well, if you are intent on tracking your AA and rebalancing, I don't understand why you would ever leave new contributions on a sort of autopilot that month after month is increasing your allocation to an asset class that is already over target? I mean, how hard is it to look at a spreadsheet once a month.

So my answer is of course direct new contributions where they should go. For those of us for whom new contributions are often not sufficient to stem the tide of the market shifting our AA's off target, that's where I get into questions and compromise.

At what point would you realize capital gains to rebalance? When %stocks is 5% over target? 10%? 20%? This is risk management afterall.

And does the situation change when you have carryforward losses? For me, if I never intentionally realized gains, my loss deduction might last through approximately 20 years of ETF distributions and $3K wages. So in effect, taking a capital gain today might shift a tax bill from 2029 to 2028? Does that change the balance?
YDNAL
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Re: Best Method/Way to Rebalance Portfolio?

Post by YDNAL »

AndromedaAsc wrote:I've been through the Boglehead Wiki and Guide, but I can't seem to find any good write up on rebalancing. Can anyone point me to some good detailed resources?
Andro,

You are complicating the heck out of this.

In accumulation (and starting out) use new monies to maintain the asset allocation (rebalance) by adding to the fund(s) that need the money.
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
maj
Posts: 448
Joined: Wed Jun 25, 2008 2:58 pm

easiest

Post by maj »

I guess most Bogleheads dislike the suggestion I will make.

Simply use balanced funds, wherein the rebalancing is done for you by the inflow of new monies, with no hesitation or 'timing temptation' to deal with, avoiding unecessary transaction expenses, and avoiding unnecessary taxes in taxable accounts.

You can choose realtively fixed allocation funds such as Balanced Index, Wellesley, Wellington, Tax Managed Balanced, or Target Retirement Income Fund;
or glide path balanced funds from among the Target Date Retirements funds,
or a flexible balanced fund from among the LifeStrategy Funds.

A single one of these,
or a combination (e.g., 50% Wellington and 50% LifeStrategy Moderate Growth--a 60% stock - 40% bond allocation;
or 50% Wellesley Income and Target Retirment Income Fund--a 33.5% stock - 67.5% bond allocation) can relieve you of a lot of grief and regret.

peace

maj
dbr
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Joined: Sun Mar 04, 2007 9:50 am

Post by dbr »

Bogleheads don't dislike balanced funds across the board, but they are a problem in taxable accounts for people with moderate to high tax rates. The problem is keeping the correct location for bonds in that case.
InvestingMom
Posts: 503
Joined: Mon Aug 20, 2007 2:45 pm

Post by InvestingMom »

I would add to your considerations the following:
  • -Are you the kind of person who wants their portfolio to be on auto pilot (someone who isn't likely to check their accounts and/or have the time to analyze it often) or are you the kind of person who likes to fiddle with their accounts often (and is fairly good with spreadsheets and analysis.)
    -Will you rebalance once a year or at shorter intervals. Or will you rebalance once your asset allocation is off by a certain percent (I think most would say to not rebalance unless you are at least 3-5% off in any category)
    -Are you in the accumulation phase or distribution phase.
    -Do you have a good system (for example Quicken) for tracking gains and losses (so that you can take advantage of short term losses to offset gains.)
    -What is your current tax rate...and cap gains rate.
It is pretty difficult to come up with a formula for rebalancing because there are many personal considerations. It will also depend heavily on whether you are in all tax deferred accounts or taxable accounts. For example, my mother is in the distribution phase and so for her I direct all of her interest and dividends to her money market account. I can then use that for her distributions and/or to rebalance. For myself, I am sort of in an accumulation phase (my husband contributes to his 401K) but we take distributions out of our taxable accounts. I only rebalance once a year for the most part. Every year I have to figure out the best method for rebalancing. Unfortunately/fortunately depending on how you look at it, it was easy to sell last year because I had losses (and now I have carryover losses to help a bit in future years.) In the past I was able to fool with the 401k accounts to accomplish the rebalancing but now they are close to being maxed with bonds and so that is hard to do. Bottom line is that it depends.....

If you are in the accumulation phase and investing through tax deferred accounts I would simply rebalance once a year by moving the money into the desired allocation (And keep the contributions the same assuming your allocation has not changed.) One other thing you can do in your taxable accounts (if you rebalance frequently) is to direct your dividend and cap gain distributions to a money market account and quarterly invest them as appropriate for maintaining your desired asset allocation.

Good luck, Investing Mom

PS
Maj, I don't think your idea is bad at all (in a tax deferred account).
maj
Posts: 448
Joined: Wed Jun 25, 2008 2:58 pm

Added note

Post by maj »

Investing mom and dbr:

I concur re the taxable issue for balanced funds, which is why I mentioned the Tax Managed Balanced Fund as a possibility. It surprises me that this fund has never reached a billion dollars in assets.)

Also, I know some investing folks who know themselves pretty well and use balanced funds in taxable accounts together with the Tax Managed Balanced Fund (e.g., 50% Wellington Fund and 50% Tax Managed Balanced Fund) simply because they relish the ease and do not mind paying the taxes. The issues they wish to avoid are permanently documenting purchases and sales, and having actually to sit down and do the rebalancing. (They mostly use Wellesley and Target Retirement Income Fund in their IRAs in order to place major emphasis on bonds.)

Mom, as you note, there are so many variables on an individual basis that it is difficult to do anything but use broad strokes.

peace
maj
InvestingMom
Posts: 503
Joined: Mon Aug 20, 2007 2:45 pm

Re: Added note

Post by InvestingMom »

maj wrote:Investing mom and dbr:

I concur re the taxable issue for balanced funds, which is why I mentioned the Tax Managed Balanced Fund as a possibility. It surprises me that this fund has never reached a billion dollars in assets.)

Also, I know some investing folks who know themselves pretty well and use balanced funds in taxable accounts together with the Tax Managed Balanced Fund (e.g., 50% Wellington Fund and 50% Tax Managed Balanced Fund) simply because they relish the ease and do not mind paying the taxes. The issues they wish to avoid are permanently documenting purchases and sales, and having actually to sit down and do the rebalancing. (They mostly use Wellesley and Target Retirement Income Fund in their IRAs in order to place major emphasis on bonds.)

Mom, as you note, there are so many variables on an individual basis that it is difficult to do anything but use broad strokes.

peace
maj
Totally agree with you conceptually (I dont follow the specific funds that you recommended.). Didn't mean to imply otherwise in my previous post. I think simplicity is extremely important for most of us and might be worth the extra taxes.

I also completely agree with your comment in your first post about going with the balanced funds to avoid the temptation to time the markets. It is almost impossible to avoid the temptation to time the markets even if it is just on a small scale (ie worrying that the fed is going to raise interest rates the next week....or thinking maybe I better wait until earnings come out...or there is always something.)

Peace to you,
Investing mom
escafandro
Posts: 26
Joined: Mon Jan 25, 2010 2:30 am

Post by escafandro »

What method would you choose if the capital gain are not a problem?
I am a foreigner, so I do not pay capital gains taxes, but yes for interest and dividends (30%).
So should I also buy individual bonds instead of a bond fund (thus not paying taxes in the U.S.)
Don´t know in this case whether to make a bond ladder or not. Any suggestions?
alenshowbrizz
Posts: 4
Joined: Mon Jul 19, 2010 5:33 am

Post by alenshowbrizz »

The best thing I can recommend is in a morning star. You can definitely create her account in a free and input your investments into the portfolio tracker or instant x-ray and it will give you a wealth of information.
The only thing we have to fear is fear itself.
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