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Wednesday, July 28, 2010

Portfolio rebalancing

One of the tasks facing the do-it-yourself investor is portfolio rebalancing to get back in realignment with the desired allocation. There is a good article on this at Smart Money. In the article, David Wray, president of the Profit Sharing/401(k) Council of America, says the two biggest mistakes 401(k) participants tend to make is to go more than a year before rebalancing and not contributing enough to receive the full employer match.

Coming up with the contribution to receive the full matching amount can admittedly be a problem sometimes. The rebalancing part is actually easy - especially in this age of low-cost exchange traded funds and available technology - if you willing to take a deep breath and deal with percentages and a pie chart.

I first look at the overall allocation- percent in stocks and percent in bonds. If it is 5% out of whack, I look to rebalance. So, for example, if 70% stock and 30% bonds is the desired allocation and markets have moved the portfolio to 75% stocks and 25% bonds, then we need to reduce stocks and add to bonds. Over the long term, this is a subtle means of buying low and selling high - it adds incrementally to return. In a simple portfolio, sell at least 5% of your SPY (etf tracking S&P 500) and buy AGG or BND (etfs tracking the bond market) with the proceeds.

Once this is determined, I look inside the broad classifications. If small cap stocks did especially well, then that would be the stock sector that would get most of the reduction. In the fixed income area, if the high yield portion had underperformed, that's where I'd add.

All of this sounds a bit more complicated than it is. In fact, I have to admit that I am surprised at the implied procrastination by David Wray's points. With Charles Schwab (as I would assume it is with most brokers), it is trivial to set up a portfolio of all your accounts, pick a desired asset allocation and then, by hitting a button, see the allocation in percent terms or as a colorful pie chart. In a matter of seconds, you can determine if you're off by more than 5%.

If you're not sure how to set this up and do it, you should contact your rep and have it explained to you. After all, this is your retirement that we're talking about.


  1. Would you also include equity in home and cash as part of the overall portfolio allocation? I have read from some who do that, and they often have suggestions such as "Don't keep more than 20% of your portfolio as home equity".

  2. I don't include one's home as a rule but do include cash. In terms of thinking about retirement anything you get out of your home is extra in my view. This includes downsizing, selling and living in South America, reverse mortgage etc. I know a lot of people whose financial plan consisted of selling their house at the outrageous prices that prevailed a few years back. Unfortunately it didn't pan out for them.
    Thanks for the comment.

  3. Wow. I have also heard of people including their homes as part of their retirement portfolio. Something about that never felt right to me. Most people's homes are not liquid. I guess with reverse mortgages, selling them, and HELOCs, you can get the equity out. However, unless you are in a dire situation, why even buy such a house at the expense of your retirement? As your article indicates, your retirement is just too important to take so lightly.

    With regard to rebalancing: how often do you typically rebalance?

  4. Hi Shawn,
    I watch my accounts on an ongoing basis and have a specified percentage - typically 5% - where if a broad class gets out of line I rebalance. If markets are stable it can be a while until I have to rebalance. If markets are volatile it can be a few times a year. With today's technology all of this is easy as long as you get your portfolios on line.