Re-balancing "organically"

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boglehat
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Re-balancing "organically"

Post by boglehat » Wed Apr 17, 2019 10:07 am

I see a lot of rebalancing threads.

Curious why it's such a heated topic. Isn't it as simple as:
- During accumulation phase, buy whatever asset class you are underinvested with every incremental dollar saved
- During withdrawal phase, sell whatever asset class you are over-invested in with every incremental dollar withdrawn

Granted, this won't work 100% of the time, such as in a very large stock market change in a short timespan, or with a portfolio that is very large relative to living expenses / savings rate. However, shouldn't this strategy take care of rebalancing for most folks, without needing to worry about transaction costs / incremental taxes paid?

tesuzuki2002
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Re: Re-balancing "organically"

Post by tesuzuki2002 » Wed Apr 17, 2019 10:10 am

yes it is basically that simple. I have been doing that method for the past decade... I'm still accumulating... but the challenge now being by contributions are minuscule compared to portfolio size.. so they don't even move the needle... so there are segments of time where I feel like I'm chasing the market to balance the AA. So far I have not made an philosophy changes and I'm fine with it.

aristotelian
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Re: Re-balancing "organically"

Post by aristotelian » Wed Apr 17, 2019 10:17 am

The larger your portfolio, the less impact incremental new dollars will have. If you view allocation in % terms, the market could outstrip your ability to get back to your allocation without buying and selling.

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bertilak
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Re: Re-balancing "organically"

Post by bertilak » Wed Apr 17, 2019 10:30 am

boglehat wrote:
Wed Apr 17, 2019 10:07 am
I see a lot of rebalancing threads.

Curious why it's such a heated topic. Isn't it as simple as:
- During accumulation phase, buy whatever asset class you are underinvested with every incremental dollar saved
- During withdrawal phase, sell whatever asset class you are over-invested in with every incremental dollar withdrawn

Granted, this won't work 100% of the time, such as in a very large stock market change in a short timespan, or with a portfolio that is very large relative to living expenses / savings rate. However, shouldn't this strategy take care of rebalancing for most folks, without needing to worry about transaction costs / incremental taxes paid?
That's it. No need to over-complicate. One's target is somewhat arbitrary anyway. Great precision is not justified. Fancy algorithms and rigid scheduling are a waste of energy.

It's easy enough to stay in the ballpark with normal activity.

If things ever seem uncomfortably out of line, just fix it.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker, the Cowboy Poet

Dandy
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Re: Re-balancing "organically"

Post by Dandy » Wed Apr 17, 2019 12:22 pm

The big risk/reward is your overall equity allocation. Keep that close to target and you should do fine if you have a relatively simple portfolio. If you have a bit more in small cap than large cap it isn't the end of the world. Remember your allocation is based on a guess what your risk tolerance is and that guess is translated into a guess as to what your overall allocation is and then a further guess at what sub allocations should be e.g. how much international equities. So, getting all worked up about rebalancing seems odd since it is based on several layers of guess work.

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bertilak
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Re: Re-balancing "organically"

Post by bertilak » Wed Apr 17, 2019 12:31 pm

Dandy wrote:
Wed Apr 17, 2019 12:22 pm
The big risk/reward is your overall equity allocation. Keep that close to target and you should do fine if you have a relatively simple portfolio. If you have a bit more in small cap than large cap it isn't the end of the world. Remember your allocation is based on a guess what your risk tolerance is and that guess is translated into a guess as to what your overall allocation is and then a further guess at what sub allocations should be e.g. how much international equities. So, getting all worked up about rebalancing seems odd since it is based on several layers of guess work.
Right.

A while back I paid a lot of attention to rebalancing. Even then I only used stock/bond ratio to trigger rebalancing, although the idea was to, at the time, rebalance even the sub-allocations. I never got to the point I needed to do anything! Thus my agreement with the OP's "organic" concept. Just do rational buying and/or selling and you will tend to stay in balance, or close enough, especially that precision is not justified..
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker, the Cowboy Poet

FreedomHawk
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Re: Re-balancing "organically"

Post by FreedomHawk » Wed Apr 17, 2019 1:03 pm

boglehat wrote:
Wed Apr 17, 2019 10:07 am
I see a lot of rebalancing threads.

Curious why it's such a heated topic. Isn't it as simple as:
- During accumulation phase, buy whatever asset class you are underinvested with every incremental dollar saved
- During withdrawal phase, sell whatever asset class you are over-invested in with every incremental dollar withdrawn

Granted, this won't work 100% of the time, such as in a very large stock market change in a short timespan, or with a portfolio that is very large relative to living expenses / savings rate. However, shouldn't this strategy take care of rebalancing for most folks, without needing to worry about transaction costs / incremental taxes paid?
There could be "phases" other than accumulation and withdrawal.

Imagine this hybrid "accumulation" scenario.....the individual may have a rollover IRA from a previous 401K and the only additional money being saved for retirement is through a company 401K plan that is invested in a target retirement fund. Because the individual isn't adding to an account outside of the 401K, the only way to really rebalance is to buy and sell securities occasionally in the IRA to get the right asset allocation.

delamer
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Re: Re-balancing "organically"

Post by delamer » Wed Apr 17, 2019 8:55 pm

If you have substantial retirement savings in a taxable account, it can get complicated to rebalance due to tax considerations.

AlohaJoe
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Re: Re-balancing "organically"

Post by AlohaJoe » Wed Apr 17, 2019 10:34 pm

boglehat wrote:
Wed Apr 17, 2019 10:07 am
I see a lot of rebalancing threads.

Curious why it's such a heated topic. Isn't it as simple as:
I dunno. Have actually run any numbers? Seen if your theory actually works in the real world?

(Anyway, I see rebalancing threads maybe once a month if that. Can't remember the last time anything "heated" about it came up.)

Let's say someone wants to have a 50/50 portfolio and their overall portfolio is $500,000.

The year is 2006. As usual, stocks outperform bonds. They need to contribute $15,000 to bonds to bring it back to even. That's a lot but within the realm of possibility.

What about in 2008? Stocks dropped a lot. They need to buy $62,000 of stocks to get back to their preferred asset allocation. That's, what?, maybe 4 years of contributions? Are you okay being "out of balance" for 4 years?

In 2009 stocks went up a lot. You need to contribute $35,000 to bonds to get back to 50/50.

In 2013 stock went up a lot, too. You need to contribute $44,000 to bonds to get back to 50/50.

Let's run a quick multi-year scenario to see how your strategy would play out. Someone starts out in 2010 with a 50/50 portfolio of $50,000. They can contribute $15,000 a year.

2010: All $15,000 goes to bonds. End up at 51/49. Not too far off your goal
2011: All $15,000 goes to stocks. End up at 50/50. Nice.
2012: All $15,000 goes to bonds. End up at 52/48. A bit of drift but nothing to worry about.
2013: All $15,000 goes to bonds again. Now we're at 59/41. That's pretty far from our target and we lose sleep at night.
2014: All $15,000 goes to bonds again. Now we're at 60/40.
2015: All $15,000 goes to bonds. A flat year for stocks so we catch up a bit. Back to 59/41.
2016: All $15,000 goes to bonds but we're still back to 60/40
2017: All $15,000 goes to bonds and we slide to 64/36.

65% stocks! When we said we wanted 50%!

So...at this point it has been 4 years we've been off our asset allocation. If you wanted 50/50 are you happy being at 65/35? And you'll notice that once you start drifting it is nearly impossible to ever catch up "organically".

It only works if your contributions are large relative to your portfolio. Which doesn't happen for most people once they get to, I dunno, late 40s?

SweetAeromotion
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Re: Re-balancing "organically"

Post by SweetAeromotion » Thu Apr 18, 2019 5:04 am

I follow OP's method, but as mentioned above when your contributions are smaller than daily movements, then the needle doesn't move a whole lot. Then your allocation can drift from what you desired. I add in re-balancing bands. Granted mine will be tighter than most would do. Given that equity to fixed income is the most important part of AA for myself, I will re-balance when I drift more than 1% out of my desired AA for equities/fixed income. I pay attention fairly close, so this is reasonable for my situation. For those that are more hands off, one can make a wider 'band' to re-balance, such as 3% or 5% where it would take larger or more sustained run-ups or sell-offs to move outside of their band.

As for large-cap to mid/small cap re-balancing, I imply almost universal total market funds, so that takes care of itself. U.S. to international re-balancing would be 3% out of my "ideal" AA, and one could make it wider/narrower as one sees fit. I don't find the need to keep these allocations as tight as I do the equities to fixed income allocations because the different types of equity positions are all somewhat correlated to each other, while equities and fixed income options are much less so.

Early on in one's allocation phase one can re-balance with only new contributions just fine. Gradually this will likely prove to not be enough, and an annual or semiannual re-balance may be in order, and then with a quite large portfolio, it may be necessary to do quarterly or when one notices a large market movement.

MnD
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Re: Re-balancing "organically"

Post by MnD » Thu Apr 18, 2019 7:19 am

in addition to the point that new investments or withdrawals are frequently inadequate to achieve reblancing objectives, the literature suggests that frequent/constant rebalancing is suboptimal on a return basis relative to infrequently performed threshold based rebalancing approaches.

From a practical perspective, attempting to rebalance with every new investment or withdrawal would be a huge nuisance for those that have their new investments or withdrawals performed automatically for amount and allocation. For those with the bulk of their investments in tax-deferred workplace and other tax-preferences retirement accounts, the transaction and tax costs of rebalancing are often zero. In taxable accounts, threshold-based rebalancing on equity declines can be coupled with tax-loss harvesting.

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Earl Lemongrab
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Re: Re-balancing "organically"

Post by Earl Lemongrab » Thu Apr 18, 2019 2:35 pm

I use the 5/25 rebalancing criteria. My spreadsheet calculates the percentage each sub-allocation is away from target and does the rebalancing check. That hasn't been triggered in a number of years. Other than that, when I have new money to go in I check the sheet to see where the imbalances are and direct the money there within reason. I won't buy REIT in taxable just because it's the furthest from target, for example.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

MnD
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Re: Re-balancing "organically"

Post by MnD » Thu Apr 18, 2019 3:01 pm

Earl Lemongrab wrote:
Thu Apr 18, 2019 2:35 pm
I use the 5/25 rebalancing criteria. My spreadsheet calculates the percentage each sub-allocation is away from target and does the rebalancing check.
I used the 5/null criteria because I don't have any suballocations. Global market cap equity 70%, fixed income 30%. Rebalance when fixed income less than 25% or greater than 35%.

If I recall this was triggered twice to buy equity in 2008/09, sell equity three times over 2009-2017 and buy equity in late 2018. With a recurrence interval of about once every two years, it's quite exciting when the rebalancing gong sounds!

I haven't rebalanced organically since 1986-1990. My 401-K was very limited and she didn't have one, so we would alternate mailing in checks to individual stock and bond mutual funds every two week in a sequence of two mailings to stock fund and 1 mailing to bond fund for a 66/34 AA. Both companies would then mail back trade confirmations which contained another postage paid return envelope and purchase slip for the next buy. If the stock and bond fund AA got out of balance we would stop alternating and keep mailing in stock purchases or bond purchases until things were rebalanced. It was always a roll of dice what the market would do between the time we mailed the check and when funds were purchased - especially times like October 1987. :shock:

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