Rebalancing within equities

[WM]

When DH and I first started investing (1998), we didn't know anything and went all into an S&P 500 managed fund frown and then wised up a little and switched to an S&P index. Then I read about diversification and we started putting money into small cap and international indexes.

Ten years later after some more reading, I got more serious about asset allocation and chose additional small % targets for DH and myself in additional classes (emerging markets, REIT, etc) (similar to the sandwich portfolio, pretty standard).

At the time, in 2008, DH didn't like the idea of moving any existing funds to re-allocate, so we just stopped adding to the existing funds and re-directed our new deposits to the areas we were short.

Well, here we are in 2010 and we're still way overweighted in S&P 500 fund (about 70% over our desired allocation) and international funds (30% over). I'd like to re-balance in one fell swoop just to finally get everything where I want it, but DH points out that in the case of, say, emerging markets, we'd be selling the 500 fund, which is down, to buy into emerging markets, which is up. Not exactly what you're typically going for with rebalancing.

Reading through the older threads, it seems as though maybe rebalancing isn't entirely critical to success, so maybe I should just leave it alone. But then I wonder if there will ever be a time to get back on track. I don't see getting there with new funds alone, although we'll continue to add where we're low.

Thoughts?

P.S. We also have some money in the TSP's G Fund standing in for our bond percentage, and conveniently that % is right where we want it. So this is only a question of what to do with the stocks.

 

[Ed_The_Gypsy]

You bond fund is where you want it, your S&P is 70% over and your international is 30% over. What is down?

I rebalance every year or two. I seem to recall three years is maybe better, but, oh, well.

 

[WM]

Well, the categories that are low for us are emerging markets (currently 0), REIT (25% low), and international bond (55% low). Not because these have gone down, but because we've only been putting money in for the last year and a half (and haven't started yet with emerging markets). Similarly, the categories that are "up" are only high because we put so much money into them, not because the funds are doing well.

I guess my real question is, I want to change my asset allocation. However, most of the money I need to move is in funds that are down about 10% for us overall. So should I wait until we "break even" on those before moving it? These are all tax-deferred accounts, if that matters.

To the extent that I can, I'll direct new deposits to the categories where we're low. But I don't see that solving the problem by itself.

 

[jIMOh]

Will 1 year of deposits correct the imbalance?

 

[walkinwood]

You could dollar-cost-average into the new assets from existing ones that are over your allocation. Since you can't know future performance, there is no hurry in getting into new assets - or leaving old ones.

I jumped in with both feet into Emerging markets (mid 2008) and REITs (late 2007 & mid 2008), thinking they had fallen sufficiently and regretted it. In the future, I will DCA into any new asset class.

 

[WM]

Will 1 year of deposits correct the imbalance?

No, not likely, even with several years. The S&P, in particular, is just too far out of whack, and it's not even doing that well right now.

You could dollar-cost-average into the new assets from existing ones that are over your allocation. Since you can't know future performance, there is no hurry in getting into new assets - or leaving old ones.

This is a good thought. And makes sense now that I realize I should be looking at this more as an asset allocation change rather than a rebalance.

 

[easysurfer]

Well, the categories that are low for us are emerging markets (currently 0), REIT (25% low), and international bond (55% low). Not because these have gone down, but because we've only been putting money in for the last year and a half (and haven't started yet with emerging markets). Similarly, the categories that are "up" are only high because we put so much money into them, not because the funds are doing well.

I guess my real question is, I want to change my asset allocation. However, most of the money I need to move is in funds that are down about 10% for us overall. So should I wait until we "break even" on those before moving it? These are all tax-deferred accounts, if that matters.

To the extent that I can, I'll direct new deposits to the categories where we're low. But I don't see that solving the problem by itself.

I'd think, a few things to consider...since you are dealing with all tax-deferred accounts, moving the money won't have a taxable gain/loss
which makes it easier. It looks like the ones that are low are the ones that are higher risk, so I'm assume have lower target allocations? If you wait until you "break even" this can be difficult as that is sort of a moving target. Of course, you have to do what you feel is most comfortable.

If it was me, I would re-allocate in huge chunks to get the percentages done and out of the way, or re-allocated dollar-cost-averaging in a few months (like by mid-year or by end of year). The main reasons are one, it's just easier to work with having the percentages right, and two if something drastically happens in the market, I'd much rather know that my percentages were ready to weather the storm.

 

[WM]

If it was me, I would re-allocate in huge chunks to get the percentages done and out of the way, or re-allocated dollar-cost-averaging in a few months (like by mid-year or by end of year). The main reasons are one, it's just easier to work with having the percentages right, and two if something drastically happens in the market, I'd much rather know that my percentages were ready to weather the storm.

Oh, I like that idea. Personally I'm inclined toward huge chunks, but DCA for 6 months would be almost as good and would make DH more comfortable. And would hedge bets a little, as suggested by walkinwood.

 

[easysurfer]

When I retired, I reallocated in huge chunks. At that time, my IRA was in Vanguard's Total Stock and 500 index funds, my 401K was in Fidelity through w*rk. To make the process easier, I had Vanguard open IRA accounts with a zero balance as placeholders (bond index, international index, prime money market). Then I rebalanced in huge chunks, all tax-deferred.

 

[LOL!]

In reality there is a pretty high correlation among all equities with each other. What the S&P500 Index does is not going to be much different from what the S&P600 small cap does. Sure, one may go up 10% over the other in a year, but so what? What the S&P500 does and what large cap foreign (say EAFE index) are also highly correlated now. Emerging markets and small cap emerging markets are always a dice roll.

I would suggest that you write down where you want to be. For example, I want to be half US, half foreign, half large, half small, half blend and half value. You have to find a way to report what your portfolio currently has. I use the Morningstar Portfolio X-ray (not the Instant X-ray). Once you know, you see what you need to do.

I would not recommend you switch all at once, though some people like that method. I would suggest that you move at least 5% of your total assets every month and commit to that. If you want 30% US Large Cap and you have 70% US Large Cap, then over 8 months you get it done.

If you move less than 5%, then it will seem like nothing is happening. If you want to go quicker, then move more on a big day. For example, if you need more bonds and stocks go up 3% (what happened on the 1st trading day this year?), you sell exchange 5% that day into bonds, but do not count it towards your regular monthly exchanges.

If you suffer from loss aversion (funds are down 10% overall), then get over it. If your S&P500 is down 10%, then those other equity funds are also down 10% or so as well. If you need to move into fixed income, then so be it.

Or do something else.

 

[jIMOh]

Originally Posted by jIMOh
Will 1 year of deposits correct the imbalance?

No, not likely, even with several years. The S&P, in particular, is just too far out of whack, and it's not even doing that well right now.

Without knowing the numbers and how far you consider way off (5%. 10% etc) My initial question just leads me to more questions

what is target allocation, based on percentages, for whole porfolio?
what is current allocation in percentages?

Guessing you are 40k-80k+ off from being balanced. I could suggest some steps to take, such as

a) direct all new monies to the assets which are below allocation %
b) direct all dividends/capital gains to a money market and then buy from that position 2-4 times per year
c) move chunks of money out of overweighted assets ("selling low") when those assets reach some number you pick (might be dollar value, allocation percentage, or percent gain).

I realize you said 2 years of deposits would not correct the problem... I would suggest not "hurrying" because as you pointed out the rebalance will be buying high and selling low if you sell anything. Its possible that the deposits and market performance will correct things for you. I would hesitate to buy anything in a rebalance which just had a run up.

 

[Ed_The_Gypsy]

I have never been any good at guessing what will go up tomorrow and what will go down. Certainly, something will go up and something else will go down. Sometimes they all go up together and sometimes they all go down together, but the trend is up.

When I was younger, I moved things a little at a time. Today, after much reading, I have chosen a mix of assets and proportions that I like and I stick with it. If I won the lottery, I would put it all into the same AA, all at once.

That way, there is less risk of losing big time if the assets that you are overweighted in today take a dive. You have to
a) believe in the value of diversification, and
b) believe in your chosen asset allocation.

Maybe your reluctance to fund the smaller assets means that you would not be comfortable with them in your AA. That's fine. Do your homework and chose what you will be comfortable with.

Some very happy people simply live off only the S&P 500 index. Maybe that is all you need.

 

[WM]

Thanks for all the replies.

jIMOh - good guess! Of the 155K we have in equities, about 40K is mis-placed right now.

Basically, I came up with a new AA a year and a half ago, and we've been putting new money into it for a year and a half, and we're still nowhere near where we want to be. Hence my impulse to just settle it once and for all.

Although I was initially thinking of this as a rebalancing, it's really just a change in AA that's has dragged on for far too long. And in general I think DCAing relatively quickly to where we want to be is probably the answer and will be a good compromise.

Once again, so happy to have this forum!