If you have not reviewed your portfolio in a while, now might be a good time to crunch the numbers.
Rebalancing portfolios is a term used to reposition investments in a portfolio back to the original targeted percentages. At Rodgers & Associates, our investment policy dictates rebalancing occurs when the stock to bond allocation is out of tolerance by 5%. All other asset classes, such as large cap value or international, are given tolerance levels as well. The idea is to trim back positions that advance over their predefined levels. By doing this you are forced to sell when the price is high and conversely, buy when prices are low. With the S&P up over 19% year to date through 7/31/13, stocks are now overweighted in most portfolios and need to be reduced to maintain targeted allocation levels.
There has been a great deal of research as to the optimum time to rebalance. According to a Vanguard study done in July of 2010, there is no obvious benefit to rebalancing quarterly, semi-annually, or annually. The issue is more directly related to transaction costs and taxes.
There are roadblocks to rebalancing. One of the biggest roadblocks is getting good information on a timely basis so that you can determine when you are truly out of balance. If a portfolio is not consolidated, this task becomes increasing complex. Assets need to be properly classified and appropriate tolerance levels need to be set. If your assets are with a broker, commissions can halt the process quickly. Fee based advisors are not compensated by commissions, so transaction costs typically don’t impede the rebalancing process. Triggering realized capital gains (especially short term gains) could also be a constraint. Last but not least, greed and fear are perhaps the biggest culprits to not executing the strategy. Emotionally, it is difficult to sell when the markets are strong and even harder to invest when markets are weak. This is counterintuitive to how our brains are wired.
Managing your wealth is a multifaceted discipline. Rebalancing portfolios is just one concept that illuminates this truth.