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I Don’t Rebalance
By Meg | December 3, 2008
Rebalancing an investment portfolio - much like diversifying and spending less than you make - is classic, sensible, research-proven, oft repeated personal finance advice. It’s important for many reasons:
- It keeps your asset allocation on target (a key component of total return).
- It forces you to buy assets when they’re down and sell them when they’re up.
- It improves performance over the long term by lessening portfolio volatility.
- It prevents you from getting too conservative or too aggressive when the market swings, thereby leaving you in a better position for downturns and rebounds.
In short, rebalancing is an “easy and effective way of maintaining the right balance between risk and reward in your portfolio,” as Money Magazine’s Walter Updegrave says in this rebalancing article.
But I’ve never done it. I have been investing for 10 years, but I’ve never rebalanced. I have never sold a single asset I’ve bought and used the proceeds to purchase an alternate asset (unless you count day trading, which of course I don’t).
I want to do it; I feel I need to do it. But there are a few things stopping me.
In the first place I haven’t really decided exactly what my asset allocation should be. I’m in my mid 20’s, and I am comfortable with risk for a variety of reasons, so one could argue I should be 100% in stocks. But I plan to “retire” from the corporate world and potentially start dipping into some of my assets by the time I’m 40, so maybe I should be more conservative. But I could get married, have kids, or change priorities by then so maybe that won’t happen after all and I should allocate based on my age and risk tolerance and be more aggressive.
And there are further complications. I am heavily invested in real estate (I own 3 properties), so one could argue I need a hefty dose of bonds - or gold or silver - to act as a real estate hedge. Also I am blessed with wealthy relatives who have gifted me a sizeable fund which sits 100% in stock index funds which I can’t/don’t currently control. Given that, should my personal funds be 100% in bonds and cash in order to counter-balance that — or should I pretend that those index funds don’t exist and allocate my retirement and other accounts as I otherwise normally would?
Which brings me to another point. Which assets am I supposed to be looking at here? My total portfolio is hugely skewed by my 3 real estate properties which have a lot of equity in them. Even leaving that out, it’s hugely skewed by the “leftover college fund” that I don’t yet control. Leaving that out it’s still skewed by my real estate reserve fund (6 months of expenses for each property is my goal) and by my emergency fund - which ideally would be a year’s worth of cash. But if I leave all that out and only look at my (relatively small) personal funds, that isn’t really accurate or helpful.
So what I’ve been doing is this: I buy and hold. My 401k is all in one 2040 retirement fund, and my Roth IRA is mostly in the Vanguard 2045 retirement fund. Each year when I make my Roth contribution I have been buying whatever I think might balance out my retirement funds somewhat - one year it was the Vanguard International Index for a little more exposure there, last year it was the Vanguard REIT index and the Vanguard Extended Market Index. Technically it’s all still “stocks” but of course it changes things to weight those sectors…
Another thing I do is invest “play” money - I have a Prosper account and a brokerage account which are both pretty small, relatively speaking. I also have a non-retirement Vanguard fund (balanced, but mostly stocks) which I throw money into when the market really dips.
I don’t think I could ever be satisfied with or stick to one asset allocation strategy. What if I wanted to pick up a foreclosure or invest in a start up or give a loan to somebody or start a business - where does that sort of activity fall into the mix? And even if it was all simple and I had one fund and I got the stocks vs real estate vs bonds vs cash thing figured out, what oh what to do about international vs domestic, large cap vs small, growth vs value?? Maybe if I had $50 million or so I could construct the perfect portfolio…
More from Meg at The World of Wealth
Topics: Miscellaneous |
December 3rd, 2008 at 4:35 pm
No offense, but the title of this article is probably incorrect. Shouldn’t it read “I Really Don’t Have a Financial Plan”?
Lots of folks would like to have the problems you describe. But none of them are really obstacles to putting together a proper investment and asset allocation plan. Your investment decisions sound random and ad hoc so you are probably missing out on some nice ROI and ROE tweaks that you could make. But you are not alone.
December 3rd, 2008 at 4:41 pm
Actually, it sounds like you are rebalancing but without a well defined target. The retirement funds automatically rebalance for you, while changing what index funds you buy you are manually rebalancing. It sounds like you should try to track it a bit better though. I will grant that it isn’t simple to rebalance complex accounts, but it can be done. Also, keeping the percentages exact isn’t as important as insuring one category isn’t far too big. It sounds like you may well have too much invested in real estate. If that is so you could consider selling a property and investing the equity in stocks/bonds or at least not buying REITs! Note that changing what you buy works as a rebalancing method for a while, but eventually your investments will grow enough that you can’t really change the allocations as the new investments are so much smaller than your total amounts invested.
You can get the composition of each mutual fund and find out how much is socks, bonds, etc. You can also break down the stocks by arge/small cap and foreign/domestic. Your brokerage may even break it down for you.
-Rick Francis
December 3rd, 2008 at 4:53 pm
@ Mr. ToughMoneyLove - Not having an asset allocation is different from not having a financial plan. I have a very specific and detailed plan which involves maxing out my retirement accounts, maintaining certain levels of reserves, and using real estate & leverage to increase my net worth. I’ll grant you that some of my investment decisions have been ad hoc and I could definitely improve - but when you’re talking about relatively small amounts of money, the most important thing is to just save it, anyway. Whether my $15K IRA has 10% bonds or 15% isn’t going to make much of a difference right now.
@ Rick - You’re right, I do try to rebalance my IRA, though without a totally defined target. And I have a detailed spreadsheet which outlines my asset allocation - it’s not that I avoid it - it just seems like my target is unrealistically far from what I can achieve right now, given the reserves I want to have and the properties that I’m managing.
And that’s one of the biggest issues - my real estate ventures are a primary component of my financial plan. I intend to have and manage 10 properties by 2017. That is going to completely skew my asset allocation - just like a small business would if I started one - and there just doesn’t seem like much I can do about that.
December 3rd, 2008 at 5:43 pm
You might as well stay 100% stocks if you aren’t going to rebalance. You effectively give up the advantages of holding the other asset classes, since they don’t effectively change your standard deviation (i.e. risk) unless you rebalance. They just drag on your long-term return.
Personally, I think rebalancing is THE secret. Well, perhaps the 2nd secret behind “live on less than 100% of your income.”
In that light you might find it unsurprising if I say that you should consider your “portfolio” to be those assets that you can rebalance. Your investment properties aren’t part of because you can’t rebalance with them. Your house is not part of your investment portfolio. Real estate that you can’t sell to rebalance is not proper diversification (in my opinion) if you believe modern portfolio theory valid and you don’t count it in your portfolio.
So focus on your liquid investments, those that you can sell. If you can’t decide what your allocation be, don’t sweat it. It is essentially impossible to pick a “best” allocation anyway. Anyone who has tried to find the efficient frontier by backtesting has discovered how elusive that is.
So, pick something sensible and do it. It doesn’t have to be perfect to help mitigate your risk and increase your return. And the truth is, there probably isn’t that much difference between “perfect” and “ok”. Having a philosophy of savings makes way more difference.
Listen to John Bogle, let your stock allocation be 100-age. Sure, maybe 20% bonds isn’t as aggressive as you might be for a young person, but the difference between that and perfect is probably less than the difference between doing something reasonable and doing what you are doing right now.
Or go against the current, and take a 60/40 allocation stocks/bonds and just stay there. You say that the bulk of your non-portfolio assets are in properties, so perhaps you have plenty of risk in your life already. Again 60/40 might not be perfect, but it probably is better than not having a plan at all.
Personally, I’ve decided on a Margaritaville portfolio for the assets I manage myself in my IRA. 33% VTI (US stocks), 33% VEU (non-US stocks), 33% TIP (inflation protected treasuries). I’ve got work accounts in retirement date funds where they are available, and a 60/40 fund where they aren’t.
Looking at it, I realize that my portfolio is a bit haphazard, but key to it is that no matter what, I rebalance. Actually most of my accounts rebalance themselves, and I do my IRA myself, but the effect is that overall my portfolio tends to stay near the same allocation. And that’s what makes things work.
December 3rd, 2008 at 10:09 pm
Hmm…I can’t give any practical advice but have you looked into consulting with a reputable fee-only financial planner? Seems like your situation is complicated enough to warrant an hour or two or help from a professional. Just a suggestion.
December 3rd, 2008 at 11:55 pm
rebalancing with your yearly investment decisions is a reasonable technique to me.
it sounds to me like someone wants you to consider even more college!
the last thing i bought and held is dollars, about 8 months ago.
December 4th, 2008 at 9:19 am
Oh, but you don’t necessarily need to jump from what you are at to the allocation you think you should be at.
You are at 100% stocks right now (except for the diversification in your target date funds). Perhaps you’d like to be more like 20%. Fine. Don’t sell 20% of your stocks right now; no one knows the future, but we’ve seen recent under performance in stocks. Usually out performance follows.
So sell 2% of your (liquid) portfolio and move it to bonds, inflation protected treasuries perhaps. Next year, aim for 4% in bonds. If stocks have a big run-up, perhaps sell a bit more of the “winnings” and move a bit faster. After a decade, you’ll be at 20% bonds or more. By the time you’re 40, you’ll be at a very reasonable age-appropriate allocation.
December 4th, 2008 at 11:58 am
Personally, I think it makes sense to have multiple portfolios depending on what you’re doing with things. Your ‘fun money’ can have it’s own allocation that you want to try out, your retirement stuff can have a more conservative or at least tried and true method based on a retirement age. Perhaps you’re saving down payment money for a house in 10 years. You might want to put that money in investments to get a little return on it, but with only 10 years, you’d want to be pretty conservative about it.
For early retirement, I plan to have two portfolios. One for pre-65 (in non-retirement accounts so I can access it) and one for post-65 (401k and IRA).
As far as actual asset allocation goes, start with something balanced (and before you ask, balanced any way it can be is good), and then tweak it to be more to your taste and risk tolerance. I’d say leave your properties out of things, but try to go light on any other real estate investments. Asset allocation is pretty arbitrary, so go with what makes sense to you and stick with it.
December 4th, 2008 at 1:17 pm
Thanks for all the great advice! As a bit of a perfectionist, it bothers me not to be able to perfectly manage and allocate all my assets - but it’s not really keeping me up at night, and there’s only so much I can do. I guess I was looking for a bit of reassurance that it’s ok to look at my assets in mini-portfolios - “retirement” being one, “real estate” perhaps being another, etc.
I really only have the ability to rebalance my retirement portfolio, so that’s the one I focus on. And it mostly sits in Target Retirement date funds, so it’s not that interesting or time consuming to manage. But at least I’m saving! As Don points out, the difference between “perfect” allocation and “ok” is somewhat negligible, even if everybody could agree on what “perfect” really means.
December 4th, 2008 at 2:32 pm
Regarding your life fund investments, you might want to look at Ric Edelson’s latest book, “The Lies About Money”. He explains why he does not like life funds. Of course, his book is all about asset allocation and he presents his own allocation plans.
December 4th, 2008 at 4:11 pm
With target retirement funds they are automatically rebalancing for you every year, no?
So if you had all of your assets in those funds, you wouldn’t have to do anything.
December 7th, 2008 at 2:33 pm
what is wrong with these people are they mad or what were they closing their eyes and walking or what. This is insane they should have been a shame of themselves