3 Steps to Rebalance Your Portfolio

Portfolio rebalancing is the process of reducing a portion of your invested assets (e.g. stocks or bonds) and increasing a different portion so the overall proportion of your various assets stay on track of your plans. If you missed my post on why you need to rebalance your portfolio periodically, you can read it here

There are problems with simply selling your excess asset types. You may not want to sell an asset held in a taxable account because selling it can trigger a taxable event, which is usually undesirable. 

I make a yearly plan anticipating how much I will invest over the course of the coming year. I invest more into the type of asset that has seen slower growth to compensate for the asset allocation discrepancy as opposed to sell a fast growing asset. (In extreme cases, I may consider sell assets in tax sheltered accounts, like my traditional 401k or my roth IRA, to avoid generating a taxable event).

So what are the specific steps I take to plan my yearly rebalance?

Let’s assume I started with one million dollars in my portfolio. In 2016, VTSAX grew 12.66% and VBTLX grew 2.6%. Assuming I made no contributions to my portfolio over 2016.

$1,000,000 on Jan 1, 2016 Jan 1, 2016 initial AA Jan 1, 2017 End of 1 yr AA
VTSAX $700,000 70% $788,620 72%
VBTLX $300,000 30% $307,980 28%

AA= Asset Allocation;VTSAX= Vanguard Total Stock Market Fund; VBTLX= Vanguard Total Bond Market Fund

On Jan 1, 2017, I am making a plan for my investment of 2017. I want to contribute to each of the funds so that they end up roughly 70/30 split by the end of 2017. Assuming I expect to invest $50,000 over the course of 2017, here are the three steps I take:

  • Add my anticipated investment for entire 2017 to my total portfolio on Jan 1, 2017. In this case, $788,620 + $307,980 + $50,000 = $1,146,600

This sum is the total amount I project to have in my portfolio by Jan 1, 2018, ignoring earnings/losses from market movement.

  • Figure out the total amount that I will have in stocks and bonds at the end of 2017 (again, ignore the growth or decline by the market):

Multiply $1,146,600 by 70% = $802,620; multiple $1,146,600 to 30% =$343,980. These are the anticipated end of next year results of each asset after my $50k investment.

  • Figure out how much I need to put into each asset and follow the plan:

The difference between $802,620 and $788,620 is $14,000 which is how much I will put into my stock fund during 2017; the difference between $343,980 and $307,980 is $36,000 which is how much I will place into my bond fund during 2017.

If I plan to invest monthly, I’d put in $14,00012 = $1166 into VTSAX (or Vanguard total market fund) and $36,00012= $3,000 into VBTLX (or Vanguard total bond fund) every month in 2017.

I used a large base sum in this example so that the monthly contributions seem to worthwhile. If your monthly contribution is small, I don’t think it’s a bad idea to contribute every 3 or 6 months.

Obviously, the market will continue to skew the proportion over the course of 2017 which means I will need to rebalance again on Jan 1, 2018. I don’t try to make my asset allocation perfectly split at 70/30. In fact, my asset allocation is rarely split at 70/30 on the dot. I consider deviation up to 5-10% throughout the year to be reasonable.

What do you think? Do you have trouble with rebalancing your portfolio? 

Still trying to figure out how to construct a portfolio? It’s not that difficult.

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