(Due to the length of this post, I've broken it down into two pieces. Here is part one.)
Professionals and personal finance bloggers often tout the benefit of rebalancing your portfolio every so often in order to maximize gains. The problem is that they never explain how to go about doing this. I try to rebalance my IRA every quarter when I receive the dividends on my investments. To me, this is the most logical because I have to reinvest the dividends anyway on all of my ETFs. If you have mutual funds that automatically reinvest dividends, doing a yearly rebalancing is all that’s really necessary (unless you are obsessive like I am).
The first thing I do is make sure that I’m still on track. I compare my overall gain to the S&P 500 returns for the quarter to see if I was able to beat the “broader market”. The S&P 500 seems to be the benchmark that most funds use, so I go ahead and use that. I use the “Spartan U.S. Equity Index Fund” because it’s the one that’s easily accessible in my 401(k). The YTD return as of 3/31/2006 was 4.19%. I calculated my return as 7.30% for the first quarter of 2006, so once again I managed to beat the market (which makes me happy).
The next step is to compare my current allocations to my targets. Generally my targets break down as:
45-55% Domestic Stocks
35-40% International Stocks
10-15% Real Estate
I break down the International category a little further into 10% Emerging Markets and 25-30% broad-based international. As you can see, my portfolio is all stock, which I feel is appropriate for someone of my age (late 20s). I have 40 years to ride the ups and downs of the stock market, so I am willing to take on more risk for the better returns that stocks have provided over the long term for the past two centuries.
(continue to part two)
5 comments:
I think you have to be careful about rebalancing too much because the trading/switching costs that you can incur.
Given that most IRA's are set up to sweep cash in the account into a Money Market account, letting dividends pile up doesn't really cost you much.
Market Participant
I agree with you, somewhat. For me, total commissions equal less than 1.5% of my portfolio per year. I believe that I can do better than that by reinvesting and further diversifying every quarter rather than allowing the funds to sit in a money market fund for a year.
As always, your mileage may vary. Yearly rebalancing may be right for some people, for me I believe that diversifying my portfolio on a quarterly basis is right for me.
Rebalancing is a good thing to do but to me its more of an art than a science. If you rebalanve too frequently, you may leave some potential gains on the table had you maintained a certain sector longer. COnversely, if you wait too long, the particular sector or asset class you're weighted toward may have run its course and be on the way down. I'm not saying that you should "time" the market, but use common sense and follow the trend (The trend is your friend). Re-balanve to stay on course with a specific allocation is the right thing to do, but doing it at pre-prorammed intervals isn't necessaruly the best thing to do either.
Rebalancing is a good thing to do but to me its more of an art than a science. If you rebalanve too frequently, you may leave some potential gains on the table had you maintained a certain sector longer. COnversely, if you wait too long, the particular sector or asset class you're weighted toward may have run its course and be on the way down. I'm not saying that you should "time" the market, but use common sense and follow the trend (The trend is your friend). Re-balanve to stay on course with a specific allocation is the right thing to do, but doing it at pre-prorammed intervals isn't necessaruly the best thing to do either.
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