While poking around this morning, I found this nice link on rebalancing which fits in well with this thread:
Tune Up Your Portfolio in Six Easy Steps - Morningstar The Short Answer
One might say there are 3 general ways of rebalancing which are really based on the "when" of rebalancing:
1. Rebalance with every new addition to the portfolio.
2. Rebalance at a set time every year: your birthday, January, etc.
3. Rebalance when certain percentage trigger points are reached, such as Larry Swedroe's 5/25 rule.
However, a hazard is that rebalancing too often appears to be detrimental. Here is a link to a missive that is worthwhile reading:
Evanson Asset Management - Asset Allocation Rebalancing and Long-Term Investment Return Information It references a paper in the Journal of Financial Planning:
FPA Journal - Optimal Rebalancing Frequency for Bond/Stock Portfolios
Back to 'when' to rebalance:
If one contributes to their portfolio every paycheck or monthly or quarterly, then one can check their asset allocation and put the new money to work in the asset class that is underweighted from their written asset allocation plan. This is relatively simple to do now that you all have your portfolios set up in the M* portfolio tool and can easily "X-ray" it. This is also reasonably tax-efficient and you are not selling any investments to create a tax liability. This would be a classic buy undervalued securities or buy low strategy. It can be very difficult to be buying REITs now or small cap value. These asset classes have gone down the most in the past year.
Another method is to check whether rebalancing is needed based on some calendar date. I personally do not like this method because lots of opportunities can be missed in between. If something drops alot but goes back up before your 'rebalance date', then you may have missed a chance to buy low. However, I think this is certainly the simplist way.
Another method is to use trigger points. Swedroe advocates a 5/25 rule where one rebalances when as asset class percentage is changed by more than 5% of the total portfolio value or by more than 25% of its target value. Here's an example: You want 30% fixed income. So your target range is really 25% to 35% of fixed income for your total portfolio value. You do not need to rebalance if your fixed income percentage falls within this range. However, if your asset allocation calls for 12% fixed income, then a 7% to 19% range would be too large, since 25% of 12% is 3%, then the range would be 12% plus or minus 3% or 9% to 15% of fixed income.
With all the rebalancing that you might do, you should take taxes into account. You do not want to be creating a tax liability if you can avoid it. If you can't avoid it, you want to try to avoid short-term capital gains and get long-term capital gains. Rebalancing in a 401(k) or IRA has no tax consequences, so look at those accounts first.
Suppose you have equities in a taxable account and bonds in a tax-deferred account. If equities drop a lot in value, you need to rebalance: so you sell some bonds in the tax-deferred account and buy equities in the same account.
Suppose equities in a taxable account have gone way up. What do you do? You don't want to necessarily sell equities and pay capital gains taxes. And you don't have anymore room in tax-deferred for more fixed income. And maybe you aren't making any contributions to tax-deferred accounts anymore. I'll leave this as a homework problem
Homework: Present here on this thread, the last act of rebalancing that you did.
