The question of how often an investor should rebalance his or her portfolio is a personal one. On the one hand, rebalancing annually sounds easy and convenient. On the other hand, rebalancing as target percentages become excessively out of line may be more beneficial.
It really depends on how much effort and time you want to put into your portfolio. Investors who tend to do the best are those who leave well enough alone and reduce trading expenses to a minimum. Someone with a 60/40 mix of stocks and bonds who rebalances every January will gain by this annual effort of selling high and buying low. If stocks are now 70% of the portfolio, 10% is sold and moved back into bonds, locking in gains and returning the risk profile to its intended level.
Similarly, if stocks had fallen to 50% of the portfolio, this investor would then sell bonds and buy more stocks while their prices were lower. This is the approach that those investors should take if they only want to spend twenty minutes a year altering their portfolios. For those of us who can handle looking at our investments more than annually, without excessive trading, rebalancing as percentages reach a certain threshold is another option.
What if an investor had a 60/40 blend in January, but by June already had a 70/30 blend? Should he or she wait until next January to sell off the hot performing assets? It depends. When a certain asset class takes off, it tends to continue its trend. If we sell too early we take the risk of leaving too much money on the table. An extreme example of this would be rebalancing into Japanese stocks. Any investor who spent the last twenty years selling off U.S. stocks and moving them into Japanese stocks would have missed out on substantial gains.
The other side of this coin is that you are now taking on far more risk than you intended. Will this cause you stress in your life knowing that you are over exposed to equities? What if the markets suddenly drop and you miss out selling high and locking in some profits?
I believe the best option for those of us who can handle looking at our portfolios often is to rebalance as our percentages stray too far from our targets. For me, the number is 5%. This is a large enough discrepancy which I feel necessitates action on my part. This may occur after 5 months or 24 months, we simply never know. This is why I feel that annual rebalancing may work for a very simple two or three fund portfolio, but for those with ten or more asset classes represented, reallocating assets as necessary may be to our advantage.
Making the decision to start investing at age 18, Karl has learned what works and what doesn't work in the world of investing. Based on his 15 years experience in the field, he has recently started a blog which aims to educate the common investor on how to best reach his or her financial goals. Join him today at http://yourinvestingblueprint.wordpress.com/about/ to begin your journey towards financial independence.
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