FREE NEWSLETTER
Go to main Forum page »
I fear rebalancing has been oversold—and that I was one of the overeager salespeople.
Rebalancing is primarily a risk-control strategy. As financial markets rise and fall, we may find we have more than our target portfolio percentage in large-cap growth shares, or emerging markets, or stocks generally. Rebalancing back to our portfolio targets trims our exposure, reducing the risk of a big financial hit if there’s a reversal in the market’s recent rise.
But rebalancing is also pitched as a way to boost returns. The notion: We should have portfolio targets for value and growth stocks, and large-cap and small-cap shares, and U.S. stocks, developed foreign markets and emerging markets. If, say, value stocks sprint ahead of growth stocks, we should rebalance back to our portfolio targets, potentially selling high and buying low.
Two decades ago, this struck me as a smart and easy way to boost returns. I was wrong. The problem: Market trends often persist for far longer than imagined. If you rebalance among market sectors every year or two, there’s a good chance this attempt to boost performance will achieve just the opposite, capping returns by choking off our exposure to a major market trend that still has many years to run.
We don’t have to look far to find examples of trends that lasted far longer than most investors expected. Emerging-market stocks had a long stretch of sparkling gains in this century’s first decade. That was followed by 15 years of stellar results from large-cap U.S. growth stocks. Rebalancing back to a portfolio’s target sector weightings would have limited these gains—what some would call cutting the flowers and watering the weeds.
To be sure, it would be great to shift from large-cap to small-cap stocks just as the market’s winds were shifting. But I’m not smart enough to succeed at that sort of market-timing, and I’m not sure anybody is.
What to do? My advice: Don’t rebalance among stock-market sectors and among bond-market sectors. The good news is, those of us who favor total-market index funds already avoid this sort of rebalancing. We never fiddle with, say, our mix of growth and value shares, instead letting our portfolio’s allocation change along with the market.
That doesn’t mean we should throw out the notion of rebalancing. I think it’s important occasionally to rebalance between stocks and more conservative investments, thereby keeping a portfolio’s risk level under control. Without that sort of rebalancing, an investment mix would likely become increasingly risky, as stocks grew to be an ever-larger portion of the portfolio.
For those with a contrarian bent, I’d also put in a plug for over-rebalancing during major stock-market declines. The notion: Overweight stocks when they’re deeply underwater. This is something I did during 2007-09, 2020 and 2022. But make sure this overweighting is temporary. As the stock market recovers, look to move back to your target stock percentage, so you don’t leave yourself vulnerable to a big stock-market decline.
In April I rebalanced funds in TIAA/CREF (educator/academic here) from US growth index (QCGRIX) to international growth (QCGLIX). This was motivated in large part by Jonathan’s posts on the value of a diversified global approach. No regrets so far. Lowered stress actually, if that can be quantified. Thank you Jonathan.
Deleted
Rebalancing, I made the ultimate changes from 60/40 to 70% S&P, 15% QQQ and 15% cash about 5 years ago. From 50 stocks to 2 main ones, and cash to tide me over the down times. In my 56 years of saving there have only been 9 down years, however it was a tough time in 2000, 2001 and 2002 my investments crashed 45% over those 3 years, however I hung tough, sold nothing, and it recovered by the end of 2004. As an Electronic Engineer, I am a BIG believer in Tech and AI. At 79, I have no fear of the market. I just cannot stand bonds, the ballast never worked for me.
I have a strong stomach for market declines, like you, and also worked in technology. I don’t know your situation, goals for investments, needs, income sources, etc. But if you rely on investments for any essential expenses, and investments are not for legacy alone, here are three questions to ponder, with some context:
Except for a relatively small and brief dip in 2022, we’ve had a strong bull market in stocks these last five years since March 2020. Valuations by some measures are now stretched higher than in 2000.
Q1: Will you be financially OK today if SPY and QQQ drop 50% or more and take 7-10 years to recover?
Today, there is a lot of overlap with intense top-20 concentration between SPY and QQQ. With the allocation you mentioned, 30% of your whole portfolio is in nine tech giants (Apple, Microsoft, Nvidia, Amazon, Google, Meta, Tesla, Broadcom) plus Pepsi.
Q2: Ever thought of replacing SPY+QQQ with say Vanguard’s VT, which gives broader U.S. stock ownership, still holds plenty of tech in its top-10, but adds some ex-US exposure where valuations are less-stretched?
Long bonds do suck as ballast, especially if the term premium is near zero as it was in 2022. If it’s solid ballast you seek, look no further than T-bills.
Q3: If your 15% cash isn’t enough to cover 7-10 years of whatever expenses you pay out of your investments, could you live with adding a slice of say 3-month T-bills to the mix?
No need to reply, silence is a fine answer. Best wishes, -D
Why no international?
I find lately that most of the rebalancing I do is directing distributions (not automatically reinvested) to the asset classes that are the most under my target allocation.
Risk fools us because we interpret the data selectively, but rebalancing is about gaining similar returns most of the time with less risk of sudden disaster.
Rebalancing can apply to many things. When it comes to bonds and stocks or their proxies, as with other balances, the problem may be that the original balance was not actually worth pursuing. Is my original balance actually worth maintaining? Why, exactly? I have previously written on Humble Dollar that I haven’t found bonds to be an attractive part of my investment mix.
But if you hold an index, you cannot easily rebalance within that index. The assumption is that the index is the balance. You could, of course, supplement that index, but that ruins the attractive simplicity–unless you use a contrary index. For example, an S&P 500 fund has over 4% of several high growth stocks. But none of those are in a typical dividend fund, so owning 25% of a dividend fund lowers the volatility of an S&P 500 fund (or total market fund, both capital weighted) essentially by 25%. I would consider this for anyone who owns an S&P fund in an attempt to avoid the volatility of individual stocks.
Regarding frequency of rebalancing, Shiller cites research that shows frequency is only limited by the hassle factor. In other words, while more frequent rebalancing is more efficient, the increase in frequency becomes progressively marginal in its utility. Part of this equation, then, becomes what I would otherwise be doing with that time.
I think what we do is aligned with the post both in practice and in principle. We rebalance on overall drift from our 60/40 stock bond asset allocation. We definitely do not tweak our individual holdings, where it be stock ETFs, REITs, commodity fund, bond ETFs or individual bonds and follow practices like 5/25. We both rebalanced and did a partial Roth conversion earlier this year when the market had a significant decline. We don’t bother trying to time it perfectly-we are happy to get a base hit without trying for a home run. With the stock market recovery I think we are currently back at around 62-63% stocks so just monitoring currently.
This is a timely post for me.
I never had to think about re-balancing because of my use of balanced and target date funds. My recent moves to consolidate most accounts, will soon have most of our funds in 3 ETFs, (domestic, international, and bond), so I will now have to deal with some basic re-balancing.
Mathematically it’s been a known that rebalancing will only increase returns if there is fairly regular market rotation. We’ve just lived thru a period where market forces squashed rotations and it makes rebalancing look bad.
It wouldn’t shock me at all if the next 20-30 years saw market rotations (small caps? value? anyone) that make rebalancing look good again.
About a year and a half ago, I wrote an article explaining why I kissed rebalancing goodbye: https://humbledollar.com/2024/02/letting-it-ride/. I haven’t wavered from that approach. At the time, my stock percentage was 57%. Now it’s up to 64%. Low maintenance “couch potato” investing suits me fine these days.
Are you considering guardrails? Like I won’t let my Stocks get larger than 75% or lower than 50%?
Scott, I’m not considering guardrails. The bond/cash portion should continue to steadily grow in nominal value over the years, providing a basic floor. If stocks eventually made up 75% or more of the portfolio, it would indicate that upside potential was being realized. If stocks were to drop to less than 50%, it would be due either to a global crisis that I likely couldn’t have market timed or a random temporary decline that should just be ridden out.
I divide my investment assets into three classifications and have these rebalancing percentage targets: 50% Growth, 33% Broad market index, and 17% Fixed income.
I do not rebalance between equities/bonds, domestic/international, growth/value, or large-cap/small-cap.
Fixed income assets are holdings that are not affected by market declines (eliminates bond funds) and are currently cash in high-yield bank accounts, money market funds, CD’s, and I-bonds. The goal here is to not ever lose value. Only real risk is to inflation and so far these have been successful in that goal.
This week I took advantage of the recent surge in growth equities to trim a little off the top of my two highest return growth funds in my Roth account and added a money market fund in that account with the proceeds. Prior to this the Roth was 100% growth. This gives me a little more tax-free fun money. I already hold enough for two years of RMDs in a money market fund in my traditional IRA in case things go south. And can fund more than six years of spending from the fixed income assets.
I will eventually change my percentage targets to reduce growth investments and increase the broad market index investments but have no time table for this and it will be slowly accomplished.
Excessive busyness kept me from checking on HD yesterday. But this morning, I lay in bed thinking of my portfolio and my plan to move my multiple stock-index funds into one or two–apparently anticipating your article. I think I’ll keep to my schedule of making the change over a few years, but the thought of the simplicity of the end result tempts me to do it and be done. Thanks for the article.
The long bull market caused me to stop dividend reinvesting and buy fixed income with the cash in my taxable account. I continue to use dividend reinvestment in my non tax accounts. I stay around 60/40 equity in the taxable account and 90/10 in non tax.
Why more of a bond mix in your taxable account as opposed to the other way around?
I only rebalance occasionally, to keep my overall stock percentage at 50%. Usually when I take my RMD. I also try to keep my international holdings around 20%. I’ve never bothered with anything more granular than that.
It’s a good point that RMDs/withdrawals can serve as a rebalancing action as well.
Currently, we are 69% stocks, 31% bonds. My wife retired 10 years ago and I retired 5 years ago. We each have pensions with COLA’s and the pensions more than handle our monthly expenses. Our target date funds will manage the rebalancing as we move toward 2035. Seems that is their easy-to-use purpose!
Is your portfolio then largely or only in target dated funds?
I also have 2035 target date funds for my retirement accounts. I had them at 2025 for years but then I realized that I wouldn’t likely be tapping them for awhile, so 2025 seems too conservative now.
We did the same!
Never rebalanced because it seemed like a lot of trouble. However, in retirement I do a small “rebalance” regarding dividends. When dividend time approaches, I compare the current fund value against the value at the last dividend. If it’s higher now, I take the cash and either spend it or put it in a tax exempt bond fund. If it’s lower, I reinvest in the fund generating the dividend.
I don’t really rebalance, and as this article said, I ended up benefiting due to the long stock bull market.
I do a small measure of occasional balancing. In my Roth IRA I have two completely different stock funds. Whichever is down when I invest in January gets funded. Also, when we sold some funds to pay off our house, we essentially did a measure of rebalancing. Otherwise, we’ve let our winners win, and we’ve been rewarded. But, as was said, no one knows which way what is going to go.
I have a small “Playground” stock brokerage account that receives a monthly payment. I use this account to scratch my investment itch without putting our real retirement funds into jeopardy and to keep me out of our advisor’s hair.
My rebalancing process is to use these monthly funds and any dividends to purchase into the lowest sector closer to the desired balance level. It doesn’t always bring everything into balance, but over time this process keeps the account close to the pivot point.
Seems to work out without having to periodically sell and purchase to reestablish the balance point.
Good Morning—you mention your advisor—may I ask what is your arrangement? Is it hourly, flat fee, percentage of assets?
Flat fee. Meetings usually last approximately 1 hour. I am not really interested in extreme detail. The primary objectives are to make sure change directions are incremental and preservation.
The idea is to “Make Haste Slowly. “
I love it. I’d like to hear more about your experience both with your “play” money and your advisor. Could be worth a post or two if you’re interested.
Basically I am a sit on your hands type of investor.
I meet with our advisor 2 times a year. At this time he describes what he believes will be the best option/direction to go with our retirement investments. If the plan makes sense to me based on current conditions, I give him permission to execute. If it doesn’t, we discuss the options until we come to an agreement and then we go forward.
I do not really track how we are doing other than check periodically to confirm the investments generally seem to move in the same direction and magnitude as the general market. Hopefully down less and up approximately the same.
The objective is to accumulate so the funds are there if and when we need them. You know, get financially healthy slowly.
As to the “Playground” account, Much the same.
It consists of stocks I select from a list known as the Champions, Challengers and Contenders. This is a list of stocks that have paid and increased dividends for more than 5 years, 10 years and 25 years in a row.
I use my monthly deposit and any dividends received to purchase the selected stock until 100 shares have been purchased. Then look for the next stock. When it is time to purchase a new stock, I rotate through the individual lists in sequence. Sales occur only if a company fails to increase its dividend 2 years in a row.
The primary purchase criteria for the next stock is that it is on the current list and near the 52 week low. The only other research I do is a quick search on current news about the stock to see if there is any news indicating potential bad changes for the company.
The only real performance parameters I have is that based on current price dividend return in 3.3% and 5.3% based on cost. Of course the longer held stocks are paying higher rates. As to total return, the stocks are approximately up 58%. Annual rate of return? Haven’t really attempted to track it and not really interested.
I have some of my equity holdings in both US and international stock funds, and bond funds (both standard short term and short term TIPS) in my traditional IRA which is the source of income. I have only a world fund in my Roth which hopefully will never need to be tapped and inherited by my children. When I calculate my quarterly net worth if I need to generate cash I sell asset(s) that are out of my target allocation, or will rebalance if an asset is more that 5% off of allocation.
Occasionally l will over balance by 5% if there is a market correction, or 10% if there is a bear market. I then return to my standard allocation when the market reaches a new peak. I don’t consider this market timing per se because I am not trying to determine the exact market peak, nor trough, just using specific market value targets to reallocate.
Sometimes I cheat a little such as in mid June when my international allocation was 4% off I rebalanced to generate cash a couple of weeks early then at the quarter’s end. I also moved up three months of my wife’s Roth conversions when the market touched bear territory in April to enable to move more shares for the same amount converted.
Always small tweaks.