Consistency is the key to rebalancing your investment portfolio. Consistency eliminates (or mitigates) emotional decisions. Emotional decisions stem from poor judgment, which stems from randomness and inconsistency.
There are two rebalancing philosophies: a scheduled “time frame” based process and an “as needed” process. No matter what method or time frame you choose, stick with it!
Time frame rebalancing requires you to turn on the computer, run the calculations (usually with a spreadsheet or similar tool), and make trades. This can happen annually, semi-annually, quarterly, or even monthly. Rebalancing based on a time frame is very beneficial in helping you become a successful investor. But when is it best to rebalance?
If you have the emotional fortitude, time, and ability to take rebalancing one step further, “as needed” rebalancing really pays off. However, it is not easy and it takes a good amount of time.
First, you’ll need to have specific tolerance ranges (such as one or two percent) and minimum trade sizes (such as 100 shares or a minimum trade size of $2,500) depending on your account size. These ranges trigger rebalancing trades when they are needed, not on some arbitrary day of the year. This gives you the opportunity to take full advantage of swings in asset classes within the year.
Rebalancing opportunities may not come on an arbitrary date (like once a year) as they do throughout the year. A consistent rebalancing program is only as good as its implementation, and buying low/selling high when the opportunity presents itself is far more advantageous than the once-a-year lazy man route (or worse, not doing it at all).
For example, on January 1, 2007, the S&P 500 started at 1,407. On December 31 of that year, the S&P 500 ended at 1,411, essentially a flat market for 500 of the largest US stocks. However, on October 8 of that year, the S&P 500 peaked at 1565. That’s a mid-year gain of over 11% and it would have been a good time to rebalance!
In fact, there were multiple opportunities in 2007 to rebalance, including a low of 1,374 on March 5 and a high of 1,553 on July 19. The novice investor (or financial advisor) who did not review his investment portfolio daily would have missed every opportunity to sell high and buy low.
If you’re not rebalancing “as needed” on your own, consider hiring a financial advisor (Google, the National Association of Personal Financial Advisors) to monitor your portfolio on a daily basis and execute these trades for you; it is very likely that they will pay their fees simply by “taking care” of their portfolio rebalancing needs.
You may think I’m mining data and I’ll be the first to admit that there are plenty of years where annual rebalancing works just fine. However, there are many years where there were seemingly “stagnant” markets, but rebalancing would have had many benefits.
Take 2011 for example. On January 3, 2011, the S&P 500 opened at 1,271. On December 31, it closed at 1,257, a meager 1% fluctuation for the year. Upon closer observation, the S&P 500 hit a low of 1,099 on the third day of October 2011. That’s more than a 13% drop from the open indices of 1,271. Wouldn’t it have been nice to invest in stocks when they are down and sell them when they are up? Rebalancing “as needed” does exactly that!
Never rebalancing is clearly the least productive investment strategy. Rebalancing at least once a year makes a lot of sense for most investors. For investors with the technology, time, and tools to rebalance “as needed” (or a financial advisor with those capabilities), investment returns should be enhanced by the extra time and effort!