Rebalancing Methods Run the Gamut

The strong performance of U.S. stocks in recent years means that many investors' portfolios may be out of balance with their target allocations. But when it comes to rebalancing a portfolio, approaches come in all different shapes and sizes.

There are those investors who rebalance at the same time each year, like clockwork, and those who do so only when their allocation falls out of whack by a given percentage. Then, there are those who don't believe in rebalancing at all, content to let the market work its magic, uninhibited by their allocation tinkering.

For some investors, January is as good a time as any to review their portfolios and make any allocation tweaks they see as needed. But when we asked readers on our Portfolio Design/Management discussion board how they handle portfolio rebalancing, the answers were surprisingly varied. You can read the full discussion here. It includes the following excerpts.

Playing the Percentages Among the most common rebalancing techniques mentioned by readers was the idea of waiting until an asset class or type falls out of whack by a given percentage before making changes.

A typical approach was that described by alex2010, who said he or she rebalances "any time any of my stocks or funds goes out of whack over or under 5%."

Kjmh53 said, "I look at my accounts twice a year. I adjust my allocations when they get out of line more than 5-10%. ... I will usually cull some money from the winners and, depending on circumstances, put it into a bond or stable-value fund for safety and future withdrawals. Otherwise, I use that money to update my allocations back to my target percentages on the laggards."

A rebalancing threshold of 5% to 10% per investment type was common, although in some cases readers set the bar lower.

MottTheHoop wrote, "If all [my] stock funds have declined some, but at least one has declined more than about 2%, then I rebalance to add more stock fund shares. If all stock funds have increased some, but at least one has increased about 10%, then I rebalance to take profits and keep the portfolio in balance."

Guruski said his or her rebalancing philosophy is the product of bad investing experiences of the past.

The commenter wrote, "We weathered 1987 with aplomb, in 2001-02 just decided to work longer. But now retired and 2008 was brutal, so we pull back when an asset class heats up beyond our allocation even 2%. In 2014, pared back stock allocation three times and upgraded our bond holdings to reduce risk."

Some readers were more systematic than others in the way they approach rebalancing. For example, GoodyearGuy wrote, "I rebalance using tolerance bands. Five percent total between equity and fixed income. Twenty percent for individual asset classes. ... I use a spreadsheet to compute the thresholds."

For others, rebalancing is more straightforward. Walls4 said he or she rebalances "when and as needed, which is seldom if ever. Only when my plain-vanilla, 60%-40% stock/bond mix gets about 10% out of whack will I rebalance. Works for me."

A few readers mentioned using allocation funds, which invest in both stocks and bonds, typically within a given allocation range, as a way to outsource rebalancing decisions to a fund manager. One such reader was theredant, who asked, "Why do the heavy lifting yourself?"

Rebalancing With RMDs, New Money Several retired readers said they use required minimum distributions, or RMDs, from their retirement accounts to rebalance. Typically, this means taking distributions from asset classes that have become too flush.

"Back when I was still adding money I simply added more to whatever had lost (or gained least) to reestablish my original allocations," wrote mwleach. "I think that is a good plan for those still building wealth. Now that I am trying to maintain wealth--withdrawing from my portfolio(s)--I generally take out enough from each asset class to get back close to target. I do this once per year, at the end of December or beginning of January, depending in part on tax considerations."

Audreyh1 wrote, "I'm retired. I rebalance at the beginning of the year when I take out my annual withdrawal. I take my distributions during the prior year in cash (i.e. don't reinvest them), most of which pay out in December. Then draw what I need for the new year in January and rebalance back to target allocation."

Other readers said the calendar also helps them determine when to rebalance.

"I review my portfolio all the time, but usually do both a rebalance and a reset of my asset allocation targets in late December," said Juris2. "I made only minor changes involving only 2% of my portfolio in December since I like my basic asset allocation, even though the performance of some of my holdings was very disappointing (e.g. international and emerging markets)."

Another rebalancing approach popular among readers is using new investment money to bring a portfolio back to its target allocation.

Bradac56 said he rebalances "once a year on my birthday. Since that's mid-February I start looking at my portfolio in January to map out my new money and rebalance allocations."

Some readers mentioned using dividends and capital gains generated by their stock and fund holdings to rebalance.

"I have turned off reinvestment of dividends and put the dividends where they're needed (for rebalancing purposes)," said artsdoc. "If all of that still leaves me off my mark, I'll then sell my 'winners' and buy my 'losers,' but only if I'm outside my allocation target by 5 percentage points (in my equity/bond allocation target)."

Rathgard uses a similar approach, writing that "I use dividends and capital gains distributions paid in cash to rebalance into the low valuation (losers) asset class. This year it was international investments, last year was real estate. I have noticed the losers tend to continue to lose for a time (since you can't pick the bottom unless you are lucky) and the winners tend to keep winning. This is what makes rebalancing difficult. Eventually this reverses as the winning asset class [gets] too expensive."

Different Rebalancing Strokes In addition to more conventional rebalancing approaches, readers shared some that were a bit more off the beaten path.

RichinTexas described one of the more hands-on rebalancing plans described by readers.

The commenter wrote, "I look at my accounts daily. Reallocate my IRA accounts every two to four months. Taxable accounts in January mostly. I am a sector/momentum investor who is retired. I enjoy it and prefer investing to watching TV. ... I never take from a fund that is doing well and give to a fund doing so-so. I just get rid of the fund doing so-so. My best sector (and largest allocation) since the Great Recession is health care and it continues to increase in its percentage. When it loses its momentum I will move on to something else."

At the other end of the spectrum was jcretirement, whose rebalancing method could be seen as far more conservative.

"All of my 403(b) contributions go to the stable-value fund,"

jcretirement

wrote. "Whenever the stable-value fund becomes 49% of my overall portfolio I put 2% of it into the

'If the Horse Is Running Well ...' A sizable minority of readers posting to our discussion forum said they rarely, if ever, rebalance and explained why.

"I'm a 'buy and hold' investor," said BoomerGuy. "If the horse is running well, I just let it keep running. I've never sold off a portion of an investment. It either all stays or it all goes."

"I do not rebalance as I run a concentrated portfolio," wrote cao68331."I like to buy good stocks and/or funds and hold them for a long period. Rebalancing might be beneficial for most people but not necessarily [a] fit [for] everyone depending on your expectation and risk tolerance."

Another reader arguing against rebalancing was festus, who said, "I agree to allow the winners to win. I've let them ride up two more years than most folks would. It's all about making money in my eyes, and money makers are why we invest in the first place. Save your scared money and allow your invested money to work for you. Think long-term. It has to be crazy out of line before I sell winners to buy losers."

Jimoak agreed. "Count me with festus," the commenter wrote. "I don't sell winners to buy more losers. It's the Peter Lynch saying that has always stuck with me about letting flowers grow and pulling out the weeds. Having said that, I do look to see why a stock is going up. If it's just powered by emotion, then I'm inclined to get out while the getting is good. But if it is a solid, growing company, then I want to be in for the long haul. Rebalancing becomes a secondary consideration at most."

Some comments have been edited for clarity and brevity.