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Topic Author
hoppy08520
Posts: 2164
Joined: Sat Feb 18, 2012 11:36 am

Hello, I've been reading about rebalancing bands and I'm just not sure if I have the math right. I hope someone can help me with an actual case study. I understand there are a number of philosophies about how and when to rebalance. I think I'm in the "rebalance when an asset class goes up or down by 10%" but I'm just not sure if I have the mechanics of this right.

Suppose that I would like to be:
78.5% Stocks
21.5% Bonds

I last rebalanced my portfolio around March and was at those percentages then. Since then the stock market has gone down which has left me with this today:

76.46% Stocks
23.54% Bonds

Suppose I would like to rebalance when the value in one investment class goes up or down 10%. Is this what people mean by "bands"?

If so, what does my stock percentage need to be to trigger a rebalance? Does it need to go up or down by 7.85 percentage points (which is 10% of 78.5%) from my desired percentage, meaning rebalance if stocks climb to 86.35% of portfolio or fall to 70.65% of portfolio? But if I waited that long, then by definition my bond allocation would be at around 29% (21.5% + 7.85% = 29.35%) if stocks were at 70.65%, which is 36% more that it was originally. Should you rebalance only when the largest asset class goes up or down 10% in value?

The bond portion of my portfolio has increased by 9.47% (23.54 / 21.5). Does this mean I'm almost at a rebalancing threshold where I should sell bonds and buy stocks to go back to 78.5/21.5? Or, as described in the paragraph above, do you look at this only for the largest asset class (in my case stocks)?

I'm confused. I've read several helpful posts and the articles below and I'm still not sure:

http://www.caniretireyet.com/blog/when- ... folio.html
http://thefinancebuff.com/5-percent-reb ... -band.html

Thanks to anyone who can set me straight. FWIW all of my retirement portfolio is in tax-advantaged accounts (401k, IRAs, TSP).
kikie
Posts: 339
Joined: Sat Apr 09, 2011 4:37 pm

### Re: Confused about rebalancing bands

Those who know do not speak; those who speak do not know.
pkcrafter
Posts: 14322
Joined: Sun Mar 04, 2007 12:19 pm
Location: CA
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### Re: Confused about rebalancing bands

Does this help?

Once you realize that rebalancing is a tool to keep risk at your target, it isn't difficult to use. I read the problem presented by JiminIllinois on the Finance Buff's site and I think it over complicates things. He's right that the change in stock allocation seems high, but the difference in potential loss between 80% stock and 75% stock is small, and that's what we are trying to keep constant. Most investors use a +/-5% band, so in your case of 78% stock, rebalancing would occur at 83% stock or 73% stock. You can use different bands or some other trigger, just remember why you are doing it.

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.
Topic Author
hoppy08520
Posts: 2164
Joined: Sat Feb 18, 2012 11:36 am

### Re: Confused about rebalancing bands

So, using 5/25 rule, and the lesser of the two used to trigger a rebalance, that means 25% of 21.5% (bonds) is 5.375% either way. But 5% is lesser, so don't rebalance unless/until bonds go to 26.5% or 16.5%.

For my stocks at 78.5%, obviously the 5% absolute will be the lesser, so don't rebalance until it gets to be 73.5% or 83.5% -- which is the the same trigger point as bonds. Which is what pkcrafter wrote -- thank you.

I guess the 25% part of the rule takes effect only for smaller asset slices (like if you have 10% in REITS or 4% in commodities).

What's interesting to see is that the 5% absolute rule in my case works out to be 9.36% for stocks, which is very close to the 10%-of-assets band. But for bonds, which is just over 1/5th of the portfolio, the rebalancing trigger won't kick in until that class grows/contracts by 23%. Intuitively, that makes sense to me. If I rebalanced bonds every time the percentage went up or down by 10%, I'd rebalance too often because it doesn't take a much to make a smaller asset class move by that much. This affirms that the larger asset class is really what drives the 10%-by-assets rule.

So, it looks like for both stocks and bonds, the "lesser" is 5% for both. So, I can just stick with 5% absolute bands. That's easy to remember. Thanks again for the pointers.
kikie
Posts: 339
Joined: Sat Apr 09, 2011 4:37 pm

### Re: Confused about rebalancing bands

I could be wrong: but i think if the actual asset value of the class you hold is 10% or less, then you 25% of the dollar value as the band.

if > 10% use 5% dollar value bands

then you can get mixed up in the 'how often' threads, i suppose i will rebalance but once / year myself and well away from the end of the year like at the end of the quarter.

i'm glad it makes sense to you, neither yours, or a re-read of mine makes it 'simple' .....
Those who know do not speak; those who speak do not know.
john94549
Posts: 4638
Joined: Tue Jul 26, 2011 8:50 pm

### Re: Confused about rebalancing bands

Personally, I re-balance on only two occasions: (1) annually, in February, to reflect age in the current calendar year. Don't ask why I selected February, as my wife's birthday is in April and mine is in May. I just do it in late February. I re-balance to "age-in-bonds"; and, (2) when our "age-in-bonds" allocation gets more than 5% out-of-whack between those annual re-balancings. That seldom occurs unless Mr. Market goes weird in a major way.* For example, we are 65. We are 35% equities and 65% fixed-income. Should our AA go to 40% equities/60% fixed-income (i.e., Mr. Market shoots up dramatically), I would sell enough equities (and re-position into bonds/CDs/cash) to get back to 35/65. Should Mr. Market tank dramatically and we go to 30/70, I would harvest enough bonds/cash to buy equities to get back to 35/65. Less than 5% "out-of-whack" I ignore. Unless it's February. Next February (2013), I re-balance to 34/66, and so on. I suspect I will stop at 25/75, as recommended.

*For example, even when Mr. Market stumbled badly last summer, only one of our accounts (my wife's 401K) got to a re-balancing band (she was supposed to be 60/40 and it got to 55/45). Still, our "overall" AA barely moved the needle. I was somewhat amazed at how much it takes to actually trigger a +/- 5% re-balance band when your stodgy portfolio is skewed to bonds/CDs and such. But, then, I guess that's the point . . . isn't it?