Part 2: When to Rebalance Your Retirement Accounts

[This is the second article in a three part series about re-balancing, the first article covered why to rebalance and the last article will cover how to rebalance your retirement accounts]

stock_market_up_downA year in the life of the stock market can be brutal.  Daily swings up and down are unpredictable at best, but we’ve seen that rebalancing can help smooth out some of this volatility.  There is a lot of argument on whether it actually increases your earnings or not, but it all depends on your asset allocation.  If you’ve decided to go the rebalancing route, the next thing you need to decide is when to rebalance.

The +/- 5% Band Method

A popular method is the +/- 5% rule, which says that you should rebalance when one of your asset classes goes up or down by 5%.  So if your desired AA is 80% stocks and it moves up to 85%, you would rebalance your account by selling some of your stocks and buying more bonds.  Although 5% doesn’t seem like a lot it takes a tremendous drop/rise in stocks to shift your portfolio by 5%.  I think people get a little too excited with rebalancing and tend to rebalance way too often.

A Large Drop In Stocks

required drop in stocks to reduce allocation by 5%

Courtesy of The Finance Buff

I pulled this chart from another great personal finance blog that I read weekly.  It shows the required drop in stocks to reduce your allocation by just 5% depending on your portfolio’s allocation to stocks.  From about 25-80% stock allocation, the required drop in stocks is around 25%.  The stock market rarely drops 25% in one year, so you can see how infrequently you’ll need to rebalance based on this method(most investors are probably in the 25-80% stock allocation range).

Can You Rebalance Too Often?

I think it’s a common misconception that you should rebalance quarterly, bi-annually, etc.  In fact, the more you rebalance the worse off your portfolio could be in certain situations.  I’m not sure who propagated this theory, but I could see why a financial advisor might advocate it.  It’s in the best interest of an advisor to have you rebalance your portfolio once or twice a year for a small 1% fee ;)

John Bogle(founder of Vanguards) has shown that certain portfolios will perform the same whether they are rebalanced or not.  Although this is a very specific case, and not representative of every situation, it reiterates the fact that rebalancing aims to reduce risk.  We know that rebalancing too much can be harmful to a portfolio, but is the risk-return of never rebalancing worth it?  I don’t think so.  So where is the sweet spot that allows investors to maximize returns with a manageable amount of risk?  Well it’s impossible to tell and I actually haven’t seen a +/- 5% drop in the stocks portion of my portfolio yet so I haven’t actually used that method(yet).

My Strategy

I take an in-depth look at my accounts once or twice a year and I’ve found the best time to rebalance for me is when I make my annual Roth IRA contribution.  Since it’s a large lump sump($5,000) I make sure to re-assess my portfolio and rebalance to my desired AA of 90% stocks/10% bonds.  I think the sweet spot is a combination of the +/- 5% and annual rebalancing.  In the future though, I’ll be contributing to my Roth IRA every two weeks so I’ll have to refine this method a bit.

Rebalancing isn’t a ton of work but in my next article, I’ll show how I do it simply and effectively.  I have a couple intuitive spreadsheets that I’ll share with you to help you rebalance efficiently.

Readers, how often do you rebalance?  Do you use the +/- 5% band method, annually or something completely different?

-Harry @ PF Pro

Part 1: Why Rebalance Your Retirement Accounts

Part 2:  When to Rebalance Your Retirement Accounts

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Part 3:  How to Rebalance Your Retirement Accounts

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Hi, I'm Harry, the owner and head writer for Your PF Pro. I started this site back in 2011 in order to create a place where young professionals could come and get all of their financial questions answered. On the site, you'll find articles on everything from asset allocation for retirement to saving money at Chipotle! So enjoy..

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  1. says

    I tend to take serious look at my portfolio twice a year with a rebalance annually. You’re right in stating that doing it too often can be bad due to costs or missing out on gains. My wife’s former employer only allowed rebalancing quarterly in their 401k, a point I never understood.

    • says

      I think it’s good to at least take a look once or twice a year, but that doesn’t necessarily mean you need to act. I’m very lucky to have an awesome 401k plan at work, so it’s interesting to hear about all the wacky rules some 401k plans have out there.

    • says

      Rebalancing won’t necessarily improve your returns a ton, but it definitely minimizes the risk and the associated ups and downs of the market. The stock market has been on a tear so far this year though, what funds are you investing in??


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