Rebalancing based on bands

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exigent
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Rebalancing based on bands

Post by exigent »

For those of you that rebalance based on percentage bands, how exactly do you implement this. Let's say, for example, that someone has a 60/40 stock bond allocation (without getting into nuances within those classes). Let's further say that they want to rebalance any time it gets at least 10% out of whack.

If it drifts to 56/44, would you rebalance? The bond portion is now 10% high, but the stock portion if 6.7% low. In other words, do you apply the percentage band to the majority or minority stake in your allocation? Or does your stake in each have to move by 10% total? Like up to 70/30 or down to 50/50?

Sorry if this comes off as overly-anal (or naive), but I'm curious to how others implement this approach.
dbr
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Post by dbr »

A possible rule is that the stock bond allocation is out of balance by 5 points.
Your 56/44 is not out of balance and 54/46 would be. It is true that the larger AA drifts proportionally less than the smaller when rebalancing is triggered.

If your rule is to reblance bonds at 10% departure, then you will rebalance stocks at less than 10% departure if stocks have a larger allocation than bonds. If your rule is to wait until the larger allocation is out by 10% then other numbers apply.

Arithmetic requires the above possibilities to work the way they do. The investor can choose as he pleases. I think the first paragraph above is a typical rule to follow on this.
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bob90245
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Post by bob90245 »

For me, it doesn't matter why the bands were triggered. I don't over-analyze these things.

If I adopted your 60/40 example, I would just wait until either 70/30 or 50/50. (Although personally, I would set a tighter band like 65/35 or 55/45. Just my preference.)
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
rwwoods
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Post by rwwoods »

I use a band of +/- 20% of the value of each holding, but the band cannot exceed 5% of the total portfolio. Total equities and total bonds each have a +/- 5% band.
Last edited by rwwoods on Tue May 11, 2010 2:57 pm, edited 1 time in total.
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georgewatkins
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Re: Rebalancing based on bands

Post by georgewatkins »

exigent wrote:For those of you that rebalance based on percentage bands, how exactly do you implement this. Let's say, for example, that someone has a 60/40 stock bond allocation (without getting into nuances within those classes). Let's further say that they want to rebalance any time it gets at least 10% out of whack.
The simplest way of implementing 10% bands with a 60/40 stock/bond allocation would look like this:
1) Stock band: 55%-65%
2) Bond band: 35%-45%

This works fine for only two asset classes. Either both assets or none will be out of balance at any time.

When dealing with multiple asset classes, I prefer to apply 10% bands to the percentage in question. Implementing that with a 60/40 stock/bond split would look like this:
1) Stock band: 54%-66% (.9*60%, 1.1*60%)
2) Bond band: 36%-44% (.9*40%, 1.1*40%)

I have found that the 2nd approach works well in practice, especially for smaller asset percentages. For example, a 10% allocation would have a band of 5-15% under the 1st approach, 9-11% under the 2nd approach.

There are plenty of opinions on the theoretical "best" rebalancing bands, but the important thing is developing a plan that you can stick with.

-George
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Post by Fear and Loathing »

That is my dilemma - establishing the right band. I have been using the 10% band. For example, using 40/60 (bonds/stock), whenever it gets 35/65 or 45/55. Unfortunately, each time it approaches 10% the market corrects, and I can't take advantage of it. I have been considering using 8% as it would allow me to rebalance more often to take advantage of the swings. I really dont know which is better or worse - or if it matters at all.
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stratton
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Post by stratton »

I do bands by each sub asset such as small value or REITs. Two weeks ago I sold some of each because they were above their 25% bands. Stocks in total were only 2% above their stock/bond percentage, but I didn't want those two assets to get too out of whack.

I do start checking with the stock/bond percentage then the US/Intl then on down to smaller ones.

Paul
leonard
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Post by leonard »

http://spwfe.fpanet.org:10005/public/Un ... ofiles.pdf

This paper from FPAnet is interesting.

Basically, it says the important part is having a rebalancing strategy. Not rebalancing does not present a good risk/return trade off. But, once you have a rebalance strategy, stick with it. The particular rebalance stratagy is less important than the fact of having one and sticking to it.
Leonard | | Market Timing: Do you seriously think you can predict the future? What else do the voices tell you? | | If employees weren't taking jobs with bad 401k's, bad 401k's wouldn't exist.
strafe
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Post by strafe »

Rebalancing controls risk and does not significantly increase returns. Don't tighten your bands so that you can rebalance more frequently! Borrowing a line from The House of God: "Do as much nothing as possible."

To answer your question, I use +/-5% absolute & approx +/-25% relative bands to trigger rebalancing. (The math works out such that allocations larger than 1/5 of the total portfolio will trip the absolute threshold and smaller allocations will trip the relative threshold.)

I rebalance only halfway back to the target allocation at the suggestion of a research paper I once read. Volatile assets (e.g. precious metals equity) deserve a wider tolerance band than stable assets (e.g. short term bonds).

Don't lose any sleep over this.
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kcyahoo
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Post by kcyahoo »

Using Excel divide your actual amount by your target amount. Then use the Conditional Formatting option to turn the cell RED if it is out of bounds. I have used 10%, 15% and 25% for individual funds in the past. It seems that at 10% I rebalanced too often and at 25% not enough. So for now I rebalance if any fund gets out of whack at the 85% or 115% mark. I have a pretty standard S&D Asset Allocation. I subscribe to the stock/bond rebalance at the 5% mark.
Retired @ 57, now 75 | was 50/45/5, then 42/54/04, now 35/60/5 | KC
YDNAL
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Re: Rebalancing based on bands

Post by YDNAL »

exigent wrote:For those of you that rebalance based on percentage bands, how exactly do you implement this. Let's say, for example, that someone has a 60/40 stock bond allocation (without getting into nuances within those classes). Let's further say that they want to rebalance any time it gets at least 10% out of whack.

If it drifts to 56/44, would you rebalance? The bond portion is now 10% high, but the stock portion if 6.7% low. In other words, do you apply the percentage band to the majority or minority stake in your allocation? Or does your stake in each have to move by 10% total? Like up to 70/30 or down to 50/50?

Sorry if this comes off as overly-anal (or naive), but I'm curious to how others implement this approach.
I rebalance using 5/25 Bands - whichever is tighter.

5% Band at the higher AA level (stock/bond split):
  • 60% Stock (band at 55% and 65%)... [25% Band (45% and 75%) falls outside tighter band]
    40% Bond (band at 45% and 35%)
25% Band at the lower AA levels (sub-asset class split):
  • 25% x 10% Small Cap Value = 2.5% (band at 7.5% and 12.5%)... [5% Band (5% and 15%) falls outside tighter band]
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
Rodc
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Post by Rodc »

kb0fhp wrote:That is my dilemma - establishing the right band. I have been using the 10% band. For example, using 40/60 (bonds/stock), whenever it gets 35/65 or 45/55. Unfortunately, each time it approaches 10% the market corrects, and I can't take advantage of it. I have been considering using 8% as it would allow me to rebalance more often to take advantage of the swings. I really dont know which is better or worse - or if it matters at all.
It does not matter in a material way.

Over any given period one method will eek out a little more return or a little less risk than other methods.

But what works best tends to be very period specific and the winning margin tiny. I have gone back and re-analyzed results from a number of studies and which method wins is a random event and the margins are well down in the noise.

Pick a method, any more or less rational method, and be done with it.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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CrankyManager
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Re: Rebalancing based on bands

Post by CrankyManager »

This question drove me out of my mind since I started investing in my 401k at my first job. People rebalance (speaking in tremendously broad terms here) for two reasons: to buy low/sell high, and to keep their risk within predefined boundaries.

After over a decade of it, I'd finally had it with trying to find the perfect percentage to trigger a rebalance. After finally getting my head out of the sand about 6 years ago, I simplified my investment choices, my allocations, and my methods. I now simply rebalance my 401k every December, and my taxable account every 15 months -- whether they need it or not -- and I find that I sleep better at night.

The only time that I broke the rule was in 2008. I will admit that I rebalanced my 401k more than once for one big one reason: The first being that I'm quite young (33) and the bear didn't scare me. Rightly or wrongly, I wanted to participate in the equity fire sale.

But more to the point, I've never found that there can be a single, simple solution. People I talk to who invest wisely all have different targets and methods, and you wind up creating a lot of noise for yourself by over analyzing all of the different methods.

In discussions with co-workers I find that the biggest mistake that they make is that they use rebalancing as a "safe" way to time the markets, and they typically fail. Younger co-workers fled to bond and cash allocations all the way to the bottom of the market, and then bought equities all the way through 2009.

What's worked for me is keeping my method simple, setting a plan down in (mostly) concrete terms, and following it.

Rebalancing for me is kinda like making sausage -- the process stinks, but the end result works.

[PS - First post on the forum! Long time lurker, first time poster.]
Scorpion
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Post by Scorpion »

I only rebalance using new money. I am 100% equity, so maybe that's part of it. As a result my actual allocation is in some cases far from my target allocation (I am mainly not tilting toward value as much as I would intend).

Cranky - welcome to the forum! Why would a frequent rebalancer have been fleeing to bonds in the crash? Their equity allocation would presumably have been going down, hence they would need to increase it to stay on target, right?
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CrankyManager
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Post by CrankyManager »

Scorpion wrote:Cranky - welcome to the forum! Why would a frequent rebalancer have been fleeing to bonds in the crash? Their equity allocation would presumably have been going down, hence they would need to increase it to stay on target, right?
Thanks! I appreciate that.

To clarify, the frequent rebalancers were probably 100% equity investors to start with. Calling what they were doing "rebalancing" is probably a bit misleading, as they were simply chasing returns among what they considered the "best" performing funds of the prior month/quarter/year.

When they identified what was happening (by looking into the past with their most recent statement), they simply chased the bond market, liquidating equity funds for bond and MM funds. Which, I'm assuming, is where they still reside. The last couple of years have been a poor time to decide that you're a conservative investor, rather than an aggressive one.

Again, sorry to misstate foolish behavior as "rebalancing." I should have been more clear.

For the record, in November of 08 I did an early rebalance from roughly a 80/20 to a 90/10. My only regret there has been that I didn't just call it 100% and make a day of it. My future plans are to pare that allocation back on the equity side on or about the year I turn 35.
dbr
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Post by dbr »

I think it can be confusing when rebalancing is used to refer to actually changing an asset allocation. More clearly, I suspect, one can say that one sets up a balanced asset allocation and rebalancing refers to returning the allocation to the original target when market moves have caused the allocation to drift away. Changing the allocation could be called resetting, or re-allocating, or something of that sort.
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