AA Re-balancing approach

[aGracefulStomp]

Hi everyone

I'd like some assistance with re-balancing for asset allocation purposes.

One approach is to re-balance every quarter, and only for those asset classes that are more than 10% out of wack. However this approach allows the smaller asset classes to become disproportionately imbalanced.

EG: 50% is stocks and 5% is bonds:

• Stocks are re-balanced when they grow to 60% of your assets, which constitutes a 20% increase.
• Bonds are re-balanced when they grow to 15% of your assets, which constitutes a 300% increase.

An alternative approach is to re-balance when the asset class is 10% out of wack relative to its ideal allocation.

EG: 50% is stocks and 5% is bonds:

• Stocks are rebalanced when they grow to 55% of your assets, which constitutes a 10% increase.
• Bonds are re-balanced when they grow to 5.5% of your assets, which constitutes a 10% increase.

The second makes sense, but I'm concerned with excessive re-balancing. Although I guess if re-balancing is limited to every half-year or even year, then it wouldn't be that often?

Thoughts?

[AdrianC]

What's the other 45% in?

[Wintergreen78]

To me it seems like either one of those would be fine. The big picture stuff is keeping spending under control and saving and investing regularly. The next step is having a reasonable asset allocation. I don’t think the exact details of how you rebalance will gave much impact on your long-term outcome.

My guess is that you will end up re-balancing every quarter if you switch to your proposed method. Changes in your larger asset classes will be enough to make your smaller asset classes move out of that narrower band. But, it won’t take a big transaction to get them back in their band. If your goal is to keep transactions to a minimum (which I think is pretty reasonable), then you are probably better off sticking with what you are doing now.

You could also do a system where you rebalance each quarter if bonds move to 15% of assets, but only rebalance if they are over 5.5% for two quarters in a row (using your example). That way you can respond to big swings more quickly, but still keep things in a tighter range.

[vand]

Band-based rebalancing makes the most sense to me if you think about what you are trying to do, which is to keep a balanced portfolio at all times... this is provided you can do it with little frictional costs.

In reality for those of us still in the accumulation pahse it's rare that you will need to actively rebalance internally, instead if you just redirect your monthly cashflow to whichever asset is most lagging then this should do most of the work.

I would also caution against setting your rebalancing boundaries too tight. It's not necessary from a performance perspective. In the classic Permanent Portfolio the 25/25/25/25 is only rebalanced once one of them gets up to 35%.

[mintleaf]

I use your second approach, and it works well. Sometimes it does end up triggering more frequent trades (like earlier this year), but intuitively that's a good thing. Rebalancing works because it exploits the relative changes between assets by buying low and selling high. When prices are volatile, there are more opportunities to capture value from the swings, and trading locks that in.