Rebalancing (triggers/timing)...

[Mark@K-Town]

This question is pretty basic, but I need some guidance regarding rebalancing a portfolio to its annual target allocations (fixed income vs. equity assets). What is the best way to approach this? In my case, I set the annual equity allocation target to be 110 minus my age. This year's equity target is 43% and the fixed income target is 57% (I'm currently about 7.5% off the equity target).

For example, rebalancing annually vs. rebalancing only when the target allocations are off by a designated "trigger" percentage (2%, 5%, ...)? In this scenario, what would be a reasonable "trigger" value?

Once the decision to rebalance has been made, then what is the best timing for that action? For example, at the beginning or end of the year or in equal amounts each quarter throughout the year? Is it better to rebalance when the stock market is up/rising or down/falling?

Rebalancing creates taxable capital gains in my case and, if I wait too long between rebalance actions, may incur additional penalties (tax bracket "creep", net investment income tax and Medicare IRMAA penalties, etc.).

Any advice will be greatly appreciated!

 

[PaunchyPirate]

I have no magic answer to the big question.

But I do make sure that I don't have any equities set up for automatic re-investment. I take all my dividends in cash and then use the proceeds to make purchases throughout the year in whichever category is underfunded according to my desired allocations. So I'm doing mini-adjustments almost every month. Lately, I've been buying a lot of fixed income with my equity dividends.

I'm not a stickler for my allocation ratio. I generally am around 60%/40% for Equities/Fixed Income. But I'm currently up to 66% in equities because I don't want to sell and incur capital gains (and lose ACA subsidies). I'm not too worried about it yet. I figure eventually, the market will adjust downward a bit and bring me back in line.

 

[Sunset]

We take dividends in cash, to provide spending or re-investment (planned vs auto). Allows to reinvest in a different category.

I've certainly heard many folks wait until the allocation is off by 5% before doing anything, otherwise you could end up doing it too frequently.

In OP's case, if really stuck on the arbitrary 110-age percentage, I'd do up to 5% as long as that didn't cause tax issues.

Of course, one has to look at their overall investments, and could do a lot of the re-balancing within IRA/401K's/Roths to avoid all tax issues.

 

[SecondCor521]

This question is pretty basic, but I need some guidance regarding rebalancing a portfolio to its annual target allocations (fixed income vs. equity assets). What is the best way to approach this? In my case, I set the annual equity allocation target to be 110 minus my age. This year's equity target is 43% and the fixed income target is 57% (I'm currently about 7.5% off the equity target).

For example, rebalancing annually vs. rebalancing only when the target allocations are off by a designated "trigger" percentage (2%, 5%, ...)? In this scenario, what would be a reasonable "trigger" value?

Once the decision to rebalance has been made, then what is the best timing for that action? For example, at the beginning or end of the year or in equal amounts each quarter throughout the year? Is it better to rebalance when the stock market is up/rising or down/falling?

Rebalancing creates taxable capital gains in my case and, if I wait too long between rebalance actions, may incur additional penalties (tax bracket "creep", net investment income tax and Medicare IRMAA penalties, etc.).

Any advice will be greatly appreciated!

Here are my rules for my finances, as well as what I do for my Dad's finances (he's 88 with Alzheimer's and I am his financial POA).

I have my target AA for fixed income, around which I set +- 25% bands. So if my AA target is 2%, my bands are 2% * 1.25 on the upper and 2% * 0.75 on the lower. I "require" myself to rebalance when my AA drifts outside of those bounds; I "permit" myself to rebalance if my AA is off target but within those bounds.

For my Dad, I have his target AA for equities, and I rebalance to that target AA monthly.

I rebalance immediately (for my Dad at all times, and for me if I am "required"). In both cases I rebalance inside our traditional IRAs so there are no tax consequences. For us, the point of rebalancing to an AA is to get our risk profiles to the appropriate level, so we don't care whether the market is rising or falling. (Although obviously the market movement does impact the size and direction of rebalancing moves.)

To minimize the capital gains from rebalancing, there are a few strategies:

1. If you draw money from your portfolio to spend, draw it from the asset that is overweighted - so if you're overweight stocks and want to spend money to buy a new car, sell stocks to do so.

2. If you have any extra income that you're not spending, use it to shore up the assets that are underweight. For example, if you have a pension or SS that more than covers spending and you're underweight stocks, use your excess SS/pension to buy stocks.

3. Treat your entire portfolio, including taxable and IRAs, as one large portfolio and maintain your AA across the entire portfolio. This way you can let your taxable account's individual AA drift however it does, and then compensate inside your IRA. On a related note, there are optimizations you can do to improve your results by placing certain assets in certain locations - see the Bogleheads' wiki article on tax efficient asset placement.

Personally since my AA to fixed income is so low and my rebalance bands are wide, I hardly ever need to rebalance. My Dad's AA drifts monthly enough to where I need to rebalance about every other month or so, but so far it has always been less than one percentage point (e.g., from 61% to 60% or whatever).

 

[Koolau]

To the extent possible, I rebalance by taking RMDs (and extra) from the pot of money needing to be reduced. If I get close, I'm happy. YMMV

 

[Midpack]

I have always used the 5/25 rule for rebalancing The Larry Swedroe 5/25 Rule - A Wealth of Common Sense. When I update our NW in Excel quarterly, I get an alert if our AA hits either trigger. I also consider taxes before I rebalance. YMMV

 

[big-papa]

The cool thing about using trigger bands such as 5/25 is that, if you're trying to hold a steady AA, you're only going to likely have fewer rebalancing events (vs, say, fixed annual rebalancing) which, over the long term, may reduce the number of taxable events that might come about by rebalancing, at least during the accumulation phase.

OP, though, is using a glide path (stocks are 110 - age) which is likely to result more frequent rebalancing regardless. I'm sure that on occasion stocks and bonds drift enough, and in the right direction that often times no rebalancing would be required. But it's not clear that applying trigger bands to a glide path is going to reduce rebalancing events as often as it would for a fixed AA. At least not clear without some sort of backtest to see what might have happened in the past.

I no longer rebalance since my bonds are now made up entirely of a TIPS ladder, but back when I did rebalance, I used the method described here (so-called adaptive bands): Rebalancing: adaptive bands (a new approach) - Bogleheads.org

By the way, the so-called "rebalancing bonus" is elusive - meaning that rebalancing in an attempt to somehow boost returns is likely to not make much, if any difference. These days many believe that rebalancing is primarily to keep an overall risk profile approximately constant and, as such, there's no reason to do it all that frequently.

Here's a good 3 part series on the subject: The Elusive Rebalancing Bonus – Part 1 – Financial Page

Cheers.

 

[OldShooter]

We don't lose a lot of sleep over it. Research I have seen has said that rebalancing has a minor effect on total return.

Rebalancing is pretty easy for us now because almost all of our investable assets are in tIRAs, so no tax consequences. When we are withdrawing because we need cash, we tend to withdraw in a way that moves us toward our planned AA. When we think our actual AA is off by a significant number, we will explicitly rebalance, though I can't recall doing that lately. We look seriously at the portfolio once a year, during the week after Christmas, so that is when we also check the AA.

 

[Montecfo]

I rebalance strategically. Since I am an active investor in individual securities primarily, I regularly have cash available from sales of securities that have reached price objectives or otherwise run their course.

I reinvest those funds tactically to stay relatively close to 60/40 equities.

But I don't sweat the details or timing much as I do not think it makes a lot of difference. And I never sell in taxable to rebalance. To me that makes little sense. But I'm about 60% tax deferred so it is fairly easy to avoid that.

 

[audreyh1]

I pretty much just rebalance at the beginning of the year when I take my annual withdrawal. If it’s not far off I don’t bother. I get a lot of distributions in December and that plus withdrawal seems to go a long way to getting the portfolio back in balance.

My triggers are very wide. If we have a sudden big drop like in March 2020 I take a look but first I evaluate opportunities for tax loss harvesting.

Before retiring I didn’t rebalance. I was almost 100% stock.

 

[Dtail]

I keep our equity exposure between 45 and 55 percent and only rebalance outside that range.

 

[Al18]

I rebalanced while working inside my 401K and IRA. I rebalance less frequently in these accounts now that I’m retired.

I sell some stocks and CD’s from after tax accounts to fund my retirement - there is NO rebalancing of these accounts.

 

[walkinwood]

Here's a good article on this topic at kitces.

Optimal Rebalancing – Time Horizons Vs Tolerance Bands

A look at rebalancing strategies, and why the optimal frequency is not annual or quarterly or monthly, but based on tolerance band thresholds instead!

www.kitces.com

I use tolerance bands, but am not particularly disciplined at keeping the individual equity assets (small v/s international vs large) in their bands. I try to keep the equity / bond asset allocation to my plan within the tolerance bands.

 

[easysurfer]

I use annual equity target as 100-age. I rebalance once a year (around New Year) so I won't forget. When I rebalance, I do so mostly in retirement accounts to not incur capital gains. That's pretty much it for me. I have things down to a routine that only today I realized the Dow hit 40,000 for the first time.

 

[Koolau]

Here's a good article on this topic at kitces.

Optimal Rebalancing – Time Horizons Vs Tolerance Bands

A look at rebalancing strategies, and why the optimal frequency is not annual or quarterly or monthly, but based on tolerance band thresholds instead!

www.kitces.com

I use tolerance bands, but am not particularly disciplined at keeping the individual equity assets (small v/s international vs large) in their bands. I try to keep the equity / bond asset allocation to my plan within the tolerance bands.

Yeah, I've had the same problem with old Megacorp stock. As it's risen, I've pretty much ignored it in relation to the remainder of my AA. Can't say why. I think it might be because it still seems unreal. Through my c@reer and after, I've bet against Megacorp stock (selling it) and I've regretted it every time. So, for now, I'm just gonna ignore it and let it ride. The remainder of my MFs and Fixed stuff is what I'll balance as much as I can. I was in good shape before Megacorp took off and if it falls back, I'll still be okay. That's probably bad (or maybe no) reasoning, but that's kinda where I'm at. YMMV