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MY PORTFOLIO HAS bounced back nicely from October 2022’s stock market low—and that’s a problem: I’ve learned over the decades that I’m not good at handling prosperity.
At issue is the question of when to rebalance my portfolio, in this case selling stocks and buying bonds to bring them back into line with my target percentages. Among experts, there’s no agreed-upon strategy, which is almost an invitation to bad behavior. We investors do better with hard-and-fast rules.
Some folks rebalance according to the calendar, such as every quarter or every year. Others rebalance when their portfolio strays by some specified amount from their target percentages, such as when their stocks go from a desired 60% of their total investment mix to either 50% or 70%.
And then there are those who—to use a technical phrase—are a little loosey-goosey about the whole thing. That’s the camp I’m in, for two reasons. First, history tells us that, at both bear market bottoms and bull market peaks, stocks can become unmoored from their fundamental value, though often this is only apparent in retrospect. Second, both on the way down and during the initial market recovery, stock prices often display momentum, thanks to a bandwagon effect as latecomers pile on the selling or buying pressure.
What does this have to do with rebalancing? When share prices fall steeply, I tend to “over-rebalance” into stocks, a strategy I described last October. This isn’t about forecasting what the stock market will do, but rather reacting to what it’s done—dropped to the point where there’s a possibility that stocks are below their fundamental value. I used over-rebalancing to good effect in 2008-09, 2020 and last year. I love buying when share prices are down sharply.
Meanwhile, when stocks start to rebound, my head tells me to hold off rebalancing back into bonds for a year or two, and instead ride the stock market’s upward price momentum. But, alas, I find this hard to do. Indeed, when I look at my own investing behavior, I see two related faults—traits I’ve tried to overcome, but with only partial success.
First, when the stock market starts to bounce back, I struggle to keep buying, even though the prices on offer may be below those at which I was merrily shoveling money into the market during the preceding decline. What’s going on here? Early in a market recovery, some folks no doubt think stocks will fall back and they’ll get another chance to buy at lower prices. But for me, a different instinct is at work—a reluctance to buy when I know better prices were available just a few days or weeks earlier.
Second, I tend to sell too early in market rallies. In other words, it isn’t just that I grow increasingly reluctant to buy as share prices bounce back. That reluctance to buy often turns to selling. For instance, during the recovery from the 2007-09 stock market collapse, I started lightening up on stocks far too soon. Admittedly, I’d gone out on a limb in late 2008 and early 2009, over-rebalancing so stocks had ballooned to some 95% of my portfolio. Still, if I’d sat tight for longer before cutting back my stock exposure, my portfolio’s performance would clearly have been better.
My hunch: I’m partly influenced by the old “get even, then get out” phenomenon. By 2010, having recouped much of my losses, I didn’t want to risk another big hit, so I pared back my stocks. To be sure, my selling wasn’t too extreme. Through the bull market of the 2010s, I kept 70% to 80% of my money in stocks—but it’s also clear I lightened up on stocks too early.
When will I start selling this time around? Partly, it’ll depend on the stock market. I assume the fitful market recovery, up almost 22% since mid-October as measured by the S&P 500, will continue as inflation eases and the Federal Reserve brings its rate-hiking campaign to an end. But I could be wrong, in which case I’ll sit tight with my overweight position in stocks for longer.
Before 2022’s bear market, I had more than 20% of my total portfolio in short-term bonds in preparation for my eventual retirement. That 20% would have given me roughly five years of potential spending money, assuming a 4% withdrawal rate. Today, I’m at around three years of potential spending money, thanks to my 2022 stock-market buying. I’d like to get back to five years’ worth.
If the stock market continues to recover, maybe I’ll do at least a little selling later in 2023, once we’re a year into the rebound. But I haven’t got a firm timetable laid out. Like I said before, it’s all a little loosey-goosey—and I worry I’ll once again find myself selling a tad too soon.
What’s the best strategy for rebalancing a portfolio? Offer your thoughts in HumbleDollar’s Voices section.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.
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Jonathan – Salute from a long time reader and fan as well as Boglehead / MBA with 40 plus years of investing in low cost equity / now index funds. It worries me when I see you write this and think of how many investors will translate your lean in / lean out out loosey goosey strategy into market timing. As a former instructor pilot in the USAF for two decades, our first rule of thumb was never to show or tell a student pilot a flying maneuver we didn’t want them to try. Oh how many people hurt themselves when they tried to do what their hero instructor pilot showed them. I would kindly state this essay falls into this category. You have a bit more experience and judgement, a bit more resources, a bit more ability to accept the risk the over balancing technique brings an investor. I think as a role model we all would be better served teaching a disciplined rebalance and stay the course in accordance with one’s long term ability and willingness to assume risk. Of course disagreeing with you on one topic (although a very important one) won’t stop me from admiring all you have done for the individual investor for decades. Thank you.
We are lucky to have “enough” as Mr Bogle would say,
ScottPoppleton@gmail.com
Syracuse, NY
Thanks for couching your criticism so kindly. I appreciate your point. I may be wrong, but I like to think HumbleDollar’s readers are more financially sophisticated than most and better able to execute an approach that involves less rigid rules, especially when the rules themselves — by the calendar vs. using rebalancing “bands” — are a matter of fierce debate.
I don’t rebalance–on the advice of John Bogle: “I am in a small minority on the idea of rebalancing. I don’t think you need to do it. The data bear me out, because the higher-yielding asset is going to be stocks over the long term. That’s the way the capital markets work. Not in every 10-year period, or even for that matter every 25-year period. But the higher-returning asset you’re getting rid of to go into a lower-returning asset, so it dampens your returns, and the differences turn out to be, if you look at 25-year periods, very, very small. And sometimes rebalancing improves your returns. Sometimes it makes them worse.”
I hold one year’s expenses in money market funds (Bucket 1) four years’ expenses in I-Bonds (Bucket 2), everything else goes to stocks (Bucket 3). I replenish Bucket 1 whenever needed. I have an aversion to bond funds and have never owned any.
Several years ago I came to realize that two of the biggest headaches of DIY portfolio management for me were tax loss harvesting (TLH) and rebalancing to maintain a target asset allocation. As a result I started to wonder why there wasn’t an automagic way of doing this, what with Silicon Valley startups and all coming up with all manner of apps to make life easier.
Enter the robo advisor. No sooner had I imagined such a thing must surely exist than I first discovered one in 2017 and promptly signed up.
For a small fee of 0.25%, it would take over the drudgery and eliminate the behavioral finance bugaboos that are these two important tasks. Not to mention it would do it easily across seven separate accounts (IRA, 401k, ROTH for each of us, plus a joint taxable account).
The robo does both of these as needed based on algorithmic set points. For TLH, when the market drops it rotates funds between ETFs that are tracking the same index, thereby netting us a nice tax loss that we can use to offset gains a tax time. That alone more than covers the cost of this great service.
Tax loss harvesting is too complicated for me. I simply keep my entire taxable equity allocation in Vanguard tax-managed funds: VTCLX (large-/mid-cap equity), VTSMX (small cap equity), and VTFMX (balanced fund–half Russell 1000 and half high quality munis). Since I’ve been holding these funds, they’ve not paid a capital gain. All three funds are quasi-index and have very low ERs. There is some minimal “active” management–to do the tax-loss harvesting, of course, and to select stocks from the index that pay relatively low dividends. This “active” management virtually eliminates capital gains and keeps taxable dividends in check.
Rebalancing seems pretty painless to me. TLH is not, and it’s easy to make mistakes. I can see the attraction there, especially if we’re talking discreet tax lots, and even more if we’re talking discreet lots of several individual stocks. If we’re only talking swapping a few index trackers for each other, not so bad, but still a pain and subject to error.
But 0.25% seems a high price to take it off my plate. Who knows when drops occur, if they’re deep enough to TLH, and how much tax I save? I may or may not make my fee back.
I actually didn’t know roboadvisors even did this, so I am going to check it out. Thanks for mentioning.
Glad to see I’m in good company in the loosey-goosey camp. As I wrote about last year, we haven’t been troubled about letting our stock segment drift lower than our target. Someday maybe we’ll get back to it, but actively doing so would likely be the result of some life change like buying property or settling somewhere, rather than being driven by “rebalancing.”
I look at a little differently. When I retired, I got social security and bought an annuity (my company had good rates) which pays for 15 years at a set rate. Basically, I treat these investments as bond funds. They are basically risk free income. As time has passed, individual bonds that I have owned in my portfolio have been called and the percentage of stocks in the portfolio has risen. When interest rates on bonds were low, the stock market was clearly the place to be. I was mostly invested in stocks, but with a strong position in cash. As interest rates have risen I have started investing in tax free bonds and CDs. I mostly buy dividend paying stocks, so if the stock market goes down, I have cash to buy more stocks. I really don’t have to worry about income for about 10 years (at which point I may be too old to care much). I don’t really worry about balancing a portfolio, just try to find the investment that will give me the better return over time with limited risk.
I follow a similar dynamic rebalancing strategy. In our case, I base my rebalancing when the market has shifted a certain amount (from the previous “all time high” – my anchor point). My current anchor point is when the DJIA hit 36,500. I then use 5% increments relative to this high mark to dynamically rebalance between 60/40 and 80/20, where my average is 70/30. As the DJIA hit 36,500, I had been slowly shifting our asset allocation to 60/40. The Dow was riding high for awhile and looked overpriced. I started shifting from 70/30 to 65/35 and then finally to 60/40 just before it hit that high mark. I don’t reduce my equity holdings any less than 60% (by choice). Then when a dip (5% drop) occurs, I rebalance to 65/35. Any variation less than 5% is noise (to be ignored). When a correction takes place (10% drop), I rebalance to 70/30. If we get into bear territory (20% drop), I am down to 80/20 and will hold regardless of further market drops. As the market recovered, I sold equities (rebalanced) with each 5% change (on the up side) although I tend to be a bit slower in responding. I am currently at 75/35 and will most likely stay at this level until the DJIA hits 36,500 again (where I will shift to 70/30 – my average). The minimum 20% “bond allocation” provides sufficient discretionary funds to last 10 years, allowing us to invest the equity portion for the long-term.
To keep my percentages comparable (going down versus going up), I always use the DJIA anchor point (36,500) as my denominator, such that a 10% correction and a 10% increase is the same amount. This allows me to clearly identify market numbers (3,650 deltas) as a percentage (10%) change. When a change of 5% or more takes place, I re-evaluate my asset allocation to rebalance. As new market highs are achieved, my anchor point shifts as well. Most years, I wind up rebalancing one or twice. I often do the rebalancing as part of our Roth conversions (where I take cash or bonds from T-IRA and buy equities in Roth) – accomplishing both conversion and rebalancing at the same time (although additional rebalancing may still be necessary). While I do have specific mathematical formulas as to when and how much to do, I do have some biases (or delays in action). For example, when the DJIA was “on the rise,” mathematically (multiple 5% increases) the numbers told me to start shifting away from equities. However, I “held on” longer (emotionally) before I finally bit the bullet and sold when the stocks were rising. It sort of “hurt” but I also knew I was taking a good profit (being fearful of a drop) and didn’t have to be too greedy. I often repeat that saying from Warren Buffet about being “fearful when others are greedy and greedy when others are fearful.”
Ironically Morningstar published this article yesterday that indirectly addresses my point below: https://www.morningstar.com/etfs/choosing-better-index-etf
The use of the Dow as your choice for an index as your standard is interesting as it only includes 30 US stocks, half of which are mega caps (>200 billion). It may be better to use an index with significantly more US, as well as some international companies to increase your diversification.
I think this issue depends largely on whether or not you are still holding individual issues versus all-market funds or target date funds. If you are using, say, a broadly diversified Vanguard fund, such as VBIAX, you should not have to worry much about rebalancing as the fund should be doing the work for you. Frankly, I stopped buying individual issues some years ago as it became clear that my stock picking skills proved the pitfalls of active management. Using diversified funds also saved me much of the effort and anxiety of deciding when and how to rebalance.
I think I’m in a similar situation to Jonathan … early 60s (actually, 63), and two or three years away from retirement. I also have about five years worth of living expenses in cash-like instruments (spread across a TIAA traditional account, I-bonds, T-bills, CDs, and an HYSA), all earning in the 5% range. The rest of my portfolio is 100% in Vanguard stock index funds. I don’t really even think about rebalancing at all, except to keep that five-year bucket in place. That means all new investment money continues to go 100% into stocks. The five years of fixed income will function as a bridge until I claim social security at age 70.
If you think about an investing horizon spanning age 25 to 95, then when you are age 60, you’re only halfway through. So for me it’s still “stocks for the long run.” Keeping the five years of expenses in safe assets, and everything else 100% in stocks, is the basic rule I follow now.
I concur with your approach, Morris. Take the living expense money off the table, put it in cash equivalents, and the rest goes to outpacing inflation. Bonds currently fail the “outpace inflation” bogey, so I see little reason for owning them.
Yes, John. And after Social Security kicks in, the amount that the portfolio needs to contribute to the five years of living expenses goes way down, leaving an even larger percentage of the portfolio to be invested in stocks.
While it’s true that TIPS are currently outpacing inflation, I still prefer stocks over the long run.
Technically TIPS and I bonds are currently outpacing inflation.
Hi Randy – true that. I should have clarified that I was thinking of treasuries and corporates.
‘I’m partly influenced by the old “get even, then get out” phenomenon.’
My issue is, for all the current “yee-ha” headlines and enthusiasm, the S&P is still around 10% below its 2022 high. It has been 18 months since we’ve seen new highs there.
Now in the “decumulation” phase, and sitting on a nice pile of 2-3 year Treasuries, I’m not eager to book a loss by selling stocks.
How often do the automatic retirement funds rebalance? (Those set on certain years as a retirement date with a certain percentage to stocks and bonds.)
Presumably they have done some sort of research on the optimal timeframe to do so. (Weekly, monthly, quarterly, etc.)
“Balanced funds” must balance continuously. E.g., Vanguard Wellington maintains a 65/35 split, Vanguard Balanced Index maintains a 60/40.
As I understand it, target-date retirement are rebalanced continuously, with new investor dollars added to areas that became underweighted that day or, alternatively, investor withdrawals taken from areas that would otherwise become overweighted.
Aah, makes sense! Obviously that is beyond the ability of most individuals to do.
I am not related to Jonathon or have any real connection with him other than this website, but please consider supporting him with a donation. It’s sometimes easily done by clicking the Donate button at the top of the website. He will respond to help with any issues. I value the insight I gain through the many voices in the articles and especially the comments. We all have uniquely personal financial situations and most of the voices are not necessarily relevant to ourselves. However it is learning how others have solved (or not solved) their own issues that help us to grow in our own way. Thank you Jonathon!
Thanks for the kind words!
I’ve tried to follow Warren Buffett’s admonition that, “Lethargy, bordering on sloth should remain the cornerstone of an investment style.” Several Vanguard LifeStrategy funds offer a mix of 80/20 bonds/stocks, 60/40 bonds/stocks, 60/40 stocks/bonds and 80/20 stock/bonds. They automatically rebalance but it might not be optimal rebalancing. Therein lies the rub: Even when doing the smart thing you might not be doing the smartest thing. But I think I can live with that.
I’ve used these funds for several family members investments with the thought that if I drop dead someday, they won’t have to make any adjustments. Things should mostly rock along.
I like this: “Even when doing the smart thing you might not be doing the smartest thing. But I think I can live with that.”
When I retired I moved from 100% stocks to 65/35 stocks/short term bonds to make sure I had access to cash if I needed it.
A couple of years ago as interest rates started to rise, I saw that even my Vanguard short and ultra short bonds were going down. I got out and went into money markets that started paying more interest. It wasn’t a lot, but I didn’t want my ‘safe’ money going down.
That worked out great and now core federal MM accounts, like at VG and Fidelity, are yielding close to 5%.
Other than that, I don’t get in or out of stocks when up or down. I re-invest dividends, so that is like dollar cost averaging, getting more shares when the market is down.
I don’t worry if my stock portfolio goes higher than my allocation as long as I have enough liquidity to last a number of years. The allocation will go up and down with the market.
This sounds like nothing more than a rationalized attempt at market timing by labeling the approach as a “loosey-goosey” disciplined method. Fascinating how even the most educated and experienced among us just can’t resist trying despite the mountain of evidence demonstrating that it can’t be done.
My father used to say, “Teach it to them in black and white and they will shade it in themselves.” I think all of us are tempted to make certain changes in our investments from time to time. As I’ve gotten older, I’ve been making fewer changes. I can’t decide if I’m getting smarter or just lazier…
Market timing involves forecasting where the market is headed. The only forecast I make is that a globally diversified stock portfolio will appreciate over the long haul. Instead, when rebalancing — or over-rebalancing — what I’m doing is what every rebalancer does: react to what the market has already done.
“Over-rebalancing” sounds like it is based on your subjective forecast derived from what the market has done. To me, that’s market timing. What every rebalancer does is follow an objective, disciplined, predetermined, planned reaction to what the market has done. Regardless, I hope your methods works for you.
Having recently retired, I am also trying to decide on that rebalance question.
I am trying to stick to a plan that provides me with one year of living expenses in cash, then I have 5 years in Bonds and the remaining in Index funds or ETF’s. I would say my version of the three buckets that I try to keep filled and am currently planning to rebalance every 6 months. Will take some time to see how that works out but at least I feel like I have a plan.
I had a similar conundrum during the Covid crash. I had received an inheritance the year before but held it all in cash because to use an Alan Greenspan term I felt the markets were “too frothy”. When the markets started to fall I came up with a plan. Since this was “found” money, and I had faith that over time the markets would bounce back. I decided when the market hit correction territory that at that point I would begin purchasing 2% of my overall portfolio in stocks after each 5% drop in the US Morningstar, and the FTSE ex US proxies. I figured that this way I didn’t need to know when the market hit bottom. Ironically my last purchases were within days of the market hitting bottom. I then sold the same amount as these proxies increased every 5%, and converted to bonds. I knew that I would be leaving some profit on the table, but I did not want to try to time the market and possibly lose my inheritance due to greed. What was the result? I earned a 7% return. Maybe some variation of this would work as a rebalancing mechanism.