Rebalance Your Portfolio in an Unbalanced World

by Guest Contributor · 3 comments

“How do I rebalance my portfolio in this crazy market?”

That was a question I received recently in a long email from James.  He explained that he was a “moderate” investor.  He had a good mix of assets in bonds (of various maturities) domestic & international stocks (small, mid and large cap), and natural resources.

Even though James was broadly diversified, he’s still getting slammed.  He’s lost over 50% of his nest egg and he isn’t happy.  He asked me if he should rebalance now and if so, how?

Why People Rebalance and How to Do It

The concept of rebalancing is meant to help you sell high and buy low.  (The “buying low” isn’t much of a problem these days….its the “selling high” that has everyone stumped).  Let’s consider a simple example.

Assume you originally invested $200,000 and you wanted a 50-50 split between bonds and stocks ($100,000 in bonds and another $100,000 in stocks).  Now, your portfolio is worth only $100,000.  The $100,000 in stocks is now only worth $40,000 and the $100,000 in bonds are now worth $60,000.

To get back to the original 50-50 split, you’d sell off $10,000 in bonds and buy stocks.  If you do this, you are buying the assets that have gotten beaten up the most (buying low) and selling the asset that has done relatively better.

Is rebalancing important now?  It depends.

First, if you are broadly diversified in equities, you probably noticed that everything got creamed last year and isn’t doing so well so far this year either.  Some advisors will tell you that it’s critical that you rebalance right now.  I’d say, right now, it might actually hurt you – at least in the short-term.  Why?  Because the investments that are doing poorly may continue to get whacked.  Nobody knows.

Personally, I think it is very important to be strategic right now.  If you are in the market, stay with high-quality equities.  Stay with short-term high quality bonds too.  This flies in the face of textbook rebalancing and if that bothers you…..don’t do it.  In normal times, rebalancing does make sense….its just that I can’t promise we’re in a “normal” period right now.

If you decide you want to rebalance, beware of two problems: it can take time and it can be expensive.

How can you solve those two problems?

Rebalance once each quarter.  I say this because even if you buy no-load funds, most have short-term redemption charges.  However, in most cases, that penalty is not imposed if you hold the funds for 90 days or more.  That means you can buy and sell at will without worrying about costs.  Please make sure to check your specific funds for restrictions.

If you want to rebalance more than quarterly, you should buy a number of funds in each category and ladder the purchases so the 90 day period expires at different times.  This is a bit more complicated and I don’t have the space to explain it further here. But if you work with an advisor, they can explain this to you.

It will be much easier to rebalance your funds if you keep all your funds at one custodian like TD Ameritrade, Fidelity or Schwab.  As an alternative, you could have all Vanguard funds or all Fidelity funds.  Just don’t have multiple accounts at multiple fund families unless you love the idea of headaches and stress.

If you decide to rebalance, it doesn’t have to be a costly affair.  If you decide NOT to rebalance, that might be ok too.  The bigger issue, I think, is how you approach your money right now.  More than ever before, it’s very important to keep your emotions out of your investing behavior if you want to stay on track.

Editor's Note: I've begun tracking my assets through Personal Capital. I'm only using the free service so far and I no longer have to log into all the different accounts just to pull the numbers. And with a single screen showing all my assets, it's much easier to figure out when I need to rebalance or where I stand on the path to financial independence.

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{ read the comments below or add one }

  • Jae Jun says:

    Rather than rebalancing by selling something, I’ve been adding to some positions with cash on hand.

    Since I like what I have, I personally dont feel the need to rebalance considering there are so many opportunities out there.

  • Neal Frankle says:

    It can cost money unless you take the steps I’ve outlined. For example, if you use no-load funds and you hold them for 90 days, in most cases it won’t cost you a cent. Also, make sure you use no-transaction fee funds.

    As an alternative, you can keep all your money at one custodian and usually they won’t charge for exchanges.

    Thanks for a good question.

  • B7 says:

    Doesn’t it cost money each time you rebalance? Won’t that reduce your returns?

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