Rebalancing Your Portfolio

It’s time to rebalance my portfolio. I laid out my asset allocation in a previous post. However one of the keys to a good asset allocation is making sure you’re sticking to the strategy you selected for yourself. I like to check up on my asset allocation twice a year, once in the middle of the year and once in late December/early January. A quick look at the calendar shows that it’s time for a check up, so late last week that’s just what I did.

For easy reference, here is the asset allocation I have set for myself: 

This asset allocation covers all my investment accounts as a whole, not each individual account. As I went over my holdings I found that several asset classes became over/under weighted to the target I have set out for them.

More specifically I was very heavily overweight in Large-Cap U.S. stocks. Which actually made up a whopping 46% of my holdings. Meanwhile, U.S. Small-Caps only made up 3.5% of my holdings. My fixed income holdings were a little underweight as well. Only 11% of my holdings were in fixed income.

A key note: When I (or when you do your own) check up on my asset allocation the mix doesn’t have to be exactly what I have outlined as my targets. Say I found my European Index fund made up 18% of my holdings instead of the 15% I’ve targeted. That’s perfectly fine. What I’m really concerned with are the groups that have gotten way out of whack like the ones I highlighted in the last paragraph.

Time to Rebalance! When we find asset classes that have gotten out of whack in our portfolio we need to rebalance our holdings in order to stick to our strategy. There are two ways of doing this:

The first is to sell shares of the funds that are performing well and have become too large a portion of your portfolio and then take that money to buy shares of the funds that are lagging behind. Personally I don’t like this way of rebalancing for a couple reasons. The is a combination of laziness and cheapness. I really don’t want to make more trades than I have to. Especially when it means paying commissions on both the buy and the sell.

The other reason I don’t use this technique to rebalance my portfolio is that I’m constantly contributing and investing to my portfolio. So selling off portions of them just to buy more the next time my automatic contributions hit is a bit dumb.

Instead, I just change my contribution amounts until the next time I rebalance. For example, I have my contributions set up exactly as you see in the chart above. But since I’m really heavy in Large-Cap U.S. stocks and light in Small-Caps. I’ll knock the percent of my contributions going toward large-caps down to 5% or even 0% for a while, and I’ll up the percentage of my contributions going to the small-caps. Then, once my asset allocation gets back in line I’ll restore the contribution amounts to normal.

I feel this is an easier way to keep my portfolio in balance. It usually only takes a few months for the underweight funds to catch back up after directing more of the new money their way.

Rebalancing your portfolio is a very important part of making your asset allocation work. If you “set it and forget it” you’ll really lose your way over time as asset classes will perform differently and you’ll be left over exposed to too much risk from one particular class.

How often do you review and rebalance your portfolio? Do you prefer to sell off part of your over performing funds and then re-invest into the lagging funds? Or like me, do you prefer to just redirect the new money you contribute to make up the difference?

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4 Responses to Rebalancing Your Portfolio

  1. Mark says:

    If you re-balance quarterly or every six months, how often do you look at changing your target asset allocation? If for example large cap stocks are outperforming small caps and you feel the market conditions are such that this trend will continue would you change your target allocation rather than re-balance?

    • FirstMillionBlog says:

      Market trends shouldn’t affect our asset allocation. The reason we invest across multiple sectors and asset types is to try and give us a solid rate of return in any economy.

      Asset classes will always perform at different rates & you or I aren’t smart enough to predict what will perform how and when. Rebalancing every so often is to account for these performance differences and to make sure you’re staying on target.

      I would say (generally) you should re-evaluate your target asset allocation every 5-10 years. While at age 30 you may want to be 80-90 in stock funds to achieve the greatest possible growth. At age 45 or 50 you’ll probably want to adjust to a more conservative mix because you simply don’t have the luxury of waiting out the big up and down swings you get from that agressive of a mix.

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