Today’s episode is about an important end-of-year planning topic: asset allocation and portfolio rebalancing.
Many otherwise smart investors set their portfolio once, but then fail to rigorously monitor their asset allocation and rebalance regularly.
Whether due to inertia or hassle, this inaction is costly. It results in lower returns and greater risk as your asset allocation drifts…bad for wealth-building.
How do you set your target asset allocation optimally and rigorously? And how do you rebalance tax-efficiently?
This week, I show you how to set your target asset allocation to match your risk profile and investment goals. I share how to track your asset allocation to see how much it has drifted from your target allocation. And I explain step-by-step how to tax-efficiently rebalance.
If asset allocation and rebalancing feel like a mystery or chore, then don’t miss today’s episode. I’ll show you how to do it systematically, efficiently, and rigorously…all in 1 hour or less per year.
What you’ll learn:
- Why it’s prudent to sell your winning investments and rebalance toward your underdogs
- How to create and define your target asset allocation starting from first principles
- How to determine your investment style and risk tolerance in an intellectually honest way
- How to track your current allocation and analyze drift from your target
- How to rebalance your portfolio tax-efficiently step-by-step
- How often you should rebalance
How often do you rebalance your portfolio? Let me know by leaving a comment!
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Links mentioned in this episode:
- Download my FREE spreadsheet to track your current vs. target asset allocation
- My 4×4 FIRE framework for creating and protecting wealth (HYW002)
- Schedule a private 1:1 consultation with me
- HYW private Facebook community
Read this episode as a post:
Today we’re going to be talking about asset allocation and rebalancing your portfolio.
This is part of my 4×4 FIRE framework for wealth management for creating and protecting wealth, which I discussed in detail in Episode 2 of the podcast.
If you didn’t happen to check that episode, I’ll link to that in the show notes page. I definitely encourage you to check that out.
But you may remember that the four quadrants of the 4×4 framework are: earn, save, invest, and protect.
Today’s discussion is part of the invest quadrant.
What we’re going to cover today, just to give a quick preview summary, is a few points:
1) Why it’s not only okay, but actually prudent to sell your winning investments and buy more underdog investments
2) How to get a crisp understanding of exactly what your asset allocation is right now, including chart visualizations, which I’m going to include a spreadsheet template to help you calculate and visualize this, as a bonus download with this episode (You’ll also want to check that out on the show notes page.)
3) How to see how far your asset allocation has drifted from your desired allocation
4) How to come up with a desired asset allocation in the first place (in terms of defining both your risk tolerance and your return criteria, and understanding how these two things trade off against each other)
5) How often to rebalance your portfolio tactically step by step
6) And finally, what are some tips and strategies for how to actually do the rebalancing tax-efficiently, and how often it’s prudent to be rebalancing your portfolio
Before we jump into all that, like I said a moment ago, I’m going to have a bonus download with this episode, which is a spreadsheet template that will allow you to put in your own data and crank out your desired and current asset allocations and visualize through charts what the difference is.
You can go download that at hackyourwealth.com/60.
Also, just for those of you who haven’t yet joined the private Hack Your Wealth Facebook group, I definitely encourage you to join us there. It’s hackyourwealth.com/fb.
It’s a great forum for you to talk and ask questions about financial independence, early retirement, tax strategies, real estate investing, side hustles, online income, career transitions, or tax tips.
Any type of advice that you’re looking for related to wealth management and financial independence and early retirement, it’s fair game.
I’m certainly in there every day, and I try to respond to everything. There’s a bunch of other folks who are active in the group as well.
I definitely encourage you to check that out and join us there: hackyourwealth.com/fb.
Let’s dive in to the meat of today’s topic, which is around asset allocation and portfolio rebalancing.
The basic idea of asset allocation is to make sure that your investment portfolio is structured in a way that provides for you the optimal comfort level in terms of your desired return and your desired risk tolerance, because these two things always trade off on each other.
If you need a higher return, you’re going to have to take on higher risk. If you want lower risk, you’re going to have to accept a lower return.
So, asset allocation is really about structuring your investment portfolio to meet the appropriate balance for those two objectives.
Portfolio rebalancing is the process of taking an investment portfolio that may have drifted over time away from your desired asset allocation and making changes to the portfolio through buy and sell investments to bring that allocation back to your desired asset allocation.
The way that portfolios drift away from their desired allocation is that some stocks do really well and they get bigger, and other stocks do less well or even lose money and they get smaller. So then you start having distortion in your portfolio compared to your desired asset allocation.
One of the questions that folks commonly have is, given that distortions in your portfolio happen when some stocks are winning and other stocks are underdogs or even losing, why would you want to get rid of your winning stocks, your winners, and buy more of your underdog investments?
The answer to that is that it’s not actually only okay to do that. It’s actually prudent to do that.
Because as your winners get bigger and bigger, they present more elevated risk of hurting your portfolio – through volatility, through stock price corrections if they’re overvalued, and just reversion to the mean.
The more you are concentrated in a particular asset class or a particular investment holding, the more you’re exposed to it.
Also remember that when you sell your winners and buy your underdogs, you’re buying your underdogs low, likely after market dips, and selling your winners high, likely after market rallies.
So rebalancing means you’re systematically capturing some of your gains and taking that risk off the table.
Now, you might ask, “What about if I miss out on phenomenal growth of companies like Amazon or Tesla?”
Well, it will definitely clip the wings of being able to ride those rollercoasters up the mountain.
Amazon and Tesla have grown tremendously, at least as of the time of this recording, particularly during the coronavirus pandemic.
But it doesn’t mean that you don’t get any exposure to those high growth stocks.
It just means that you keep your exposure at an intentionally decided level, and that you decided on that level beforehand, when you were levelheaded and cool-headed, rather than deciding on an allocation in the heat of the moment when you’re experiencing, say, stock market euphoria as Amazon and Tesla and companies like that are rallying really strongly.
Not necessarily due to any market fundamentals, but just due to popularity of the stock and a lot of people wanting to invest in them.
So, by having an intentional asset allocation, you keep your exposure at that previously intentionally decided level, and that limits your risk.
And it makes your investment outcomes a product of an intentional choice as an investor rather than making your investment outcomes a product of speculation of “How much higher can your winning stocks go? How much higher can you ride this thing?”
Which, really, at the end of the day, is just gambling rather than investing.
You can actually do really well by dumping a ton of money in Amazon and watching that ride up.
And Amazon is a great company. I’m not saying you shouldn’t own Amazon. Amazon is a fantastic company.
Especially if you had gotten in earlier before all the coronavirus stuff, it has had a breathtaking rise. It’s a really strong company and it’s going to, I’m sure, do very well.
But if you’re going to invest in a stock like Amazon, make sure you really understand the company and have a real thesis behind why you think it’s going to continue to grow much higher than it currently is rather than just investing in it just because it happens to be going higher and you think you’re going to be able to sell it and capture a big gain before there’s any type of price correction.
My only point is that if you have experienced a lot of growth from picking individual high growth stocks, like the couple I’ve mentioned (I’m not recommending either of them, by the way)…
And now that’s overweighted in your portfolio, you should really consider taking some of that risk off the table, taking some of your winnings off the table, and rebalancing back toward a desired asset allocation.
Let’s talk a bit about how to get a crisp understanding of exactly what your asset allocation is right now, and how to see how far your asset allocation has drifted from your desired allocation.
To get really good insight on this, you have to first know what your desired asset allocation actually is.
How do you come up with a desired asset allocation?
At its core, it is about understanding, first and foremost, what your risk tolerance and your return criteria are (as I mentioned earlier at the beginning) and understanding how these two things trade off against each other.
The higher your risk tolerance, the higher returns you can expect because you can pursue higher-growth stock investments, etc.
But that also means your risk of loss, your volatility risk, also increase.
If you don’t need that money, or at least you don’t need it right away, then maybe you’ll be fine either way. But if you do need that money, then you’re going to need to think hard about what you can afford to risk in your investment portfolio.
And vice versa: The lower your risk tolerance, the lower returns you can expect. But also the lower risk of loss and the lower volatility risk, etc.
All that might seem intuitive. So it helps to start this analysis by asking yourself, “What kind of investor are you?”
There’s really three questions you should ask yourself:
1) Are you a passive investor or an active investor?
2) What is your time horizon for needing the money?
3) What is your risk tolerance profile?
I want to dive into and spend a little bit of time on each of these three things.
On the first one, “Are you a passive investor or an active investor?” this is about: do you want to just set and forget your investments and don’t want to be bothered with having to analyze your investments regularly and build spreadsheets around them?
Or do you want to be more hands-on, where you’re actively reading about and evaluating investments, following your portfolio’s progress and constantly scrutinizing your holdings, potentially buying and selling investments frequently to take advantage of opportunities that you believe exist in the market?
The more passive you are, the more you’ll want to invest in, for example, whole indexes as opposed to individual securities, whereas the more active you are, the more you might be interested in investing in individual stocks and securities.
On the second question around “What is your time horizon?” this is really about what is the timescale on which you expect you will need to start withdrawing your assets to spend in retirement?
Your risk tolerance is going to change depending on whether you need the money in one year, in three years, five years, 10 years, 20 years, 30 years, or even longer.
The sooner you need the money, the less you can afford to risk it on higher risk, higher return investments – because if you take a quick loss, you might not have enough time, enough runway left, to build it back up before you actually need to withdraw the money.
Likewise, the later you need the money, the more you can afford to postpone the withdrawals, the more you can afford to invest in those higher return, higher risk investments – because even if you do take a loss, you might still have enough time to build it back up.
The third question around “What is your risk tolerance profile?”
Risk tolerance is really a personal temperament question, a psychological question. How do you emotionally handle risk?
If you’re Warren Buffett and you have nerves of steel and you don’t ever get emotional when you lose money, and you can coolly and rationally invest in a very calculated way, then your psychological risk tolerance is probably pretty darn high.
You don’t get fazed by things like volatility, so you will more likely stick to your investing plan and not deviate from it when the poop hits the fan.
And as a result, you can more confidently invest in higher risk, higher return investments.
Whereas, if you get really nervous and jittery and are prone to making rash decisions, such as selling your investments when the markets are crashing, like they did during the coronavirus crash before, then your risk tolerance is probably lower.
You’re more likely going to deviate from a previously set investment plan when the markets are gyrating. And over time, you’re statistically going to lose because you cannot consistently predict the whiplashes and whims of short-term market movements.
It’s just like gambling. You may get lucky once or twice, but over time, the house always wins.
When it comes to your risk tolerance profile, a helpful framework is to think about risk tolerance in terms of five different levels: Level 1, being defensive; Level 2, being conservative; Level 3, being balanced; Level 4, growth; and Level 5, aggressive.
Let me deep dive on each of these a little bit to give some sense of how to think about these.
I’m going to give personal opinion heuristics here around what type of return and risk profile I think constitutes each of these levels. Other financial advisers may have different opinions, but these are the ones that I have observed generally work for each of these five levels.
But certainly, search around. Do additional reading and diligence, if that helps. But you can use what I’m about to describe as a quick, useful rule of thumb framework.
Level 1: Defensive
In terms of expected return, I think of this generally as between 2-5% annualized return.
Your goal here is extreme capital preservation. You’re willing to incur very little risk.
This might suggest you should be heavily focused on the safest investments: government treasuries, even CDs at banks, with very little stock exposure, and even where you do have stock exposure, it’s focused on the safest blue chip stocks.
A potential optimal allocation for this type of profile might be, say, 10% stocks, 40% bonds, 50% treasuries, CDs, cash equivalent, marketable securities, things like that.
Very conservative, very little stock (10%), and 90% fixed income or risk-free type of assets.
Level 2: Conservative
I generally think of the expected return profile being somewhere between 4-7% annualized return.
Here your goal is still largely capital preservation, but now you’re open to more market exposure, with your focus largely still on investment grade bonds, blue chip stocks, and still with a healthy amount of risk-free allocation in things like government treasuries.
A potential optimal allocation might be something like 30% stocks (up from 10% in Level 1), 40% bonds, maybe 30% treasuries, CDs, cash, marketable securities, etc.
So you can see already there’s a shift in the potential optimal allocation from Level 1 to Level 2, where your stock proportion increases from 10% to 30%, your bond proportion stays the same, and your treasuries and marketable securities and cash equivalent bucket decreases from 50% to 30%.
Level 3: Balanced
I generally think of the expected return profile for this being somewhere between 6-10%, depending on the year.
And this is where your goal is some exposure to stocks, but also some exposure to bonds.
You’re probably mostly focused on investment grade and blue chip securities, but now you have some exposure to growth-oriented or higher growth investments.
Additionally, you’re probably ratcheting down your risk level as you get older, to decrease your exposure as you get closer to your withdrawal horizon.
This is more or less the investing philosophy of target date funds that you often see in retirement plans like 401(k)s.
They start out more heavily weighted toward stocks, less weighted toward bonds and treasuries. And then as you get older and approach your retirement horizon, those balances slowly invert over time.
An optimal allocation in this level might be something like 50% stocks (half your portfolio in stocks), 30% bonds, 20% treasuries, CDs, cash equivalents, marketable securities.
So now you’re balanced in that you have half stock investments, half fixed income and a marketable securities type of investments. So your stock exposure is definitely increasing, and your bond and treasuries, CDs, and cash exposure is decreasing.
Level 4: Growth
Here, the expected return profile might be somewhere between, say, 8-15% annualized, depending on the year.
Your goal is less about capital preservation and now more about growing your capital, or capital appreciation.
To do this, you’ll need higher exposure to stocks.
You’re probably looking to invest less in stable dividend stocks, less in those blue chip stocks, and more in growth companies or indexes that track growth sectors – sectors like healthcare, technology, maybe emerging markets, etc.
You’re probably, at this point, a majority weighted in stocks at Level 4.
Maybe you have, as your potential optimal allocation, 70% stocks (up from 50% in Level 3), 25% bonds, maybe 5% treasuries, CDs, and cash.
So now you can clearly see there is a lean toward stock investments. And then even within stock investments, you’re now probably trading more into higher growth, but also higher risk investments.
You probably still have some mix of blue chip dividend stocks, but it’s less than Level 3, for sure.
Level 5: Aggressive
Here, you’re probably looking at 12-20% annualized return, depending on the year.
Here, you are at an aggressive risk tolerance. You’re looking for the highest return, even though you know the risk of loss is quite high.
You probably shouldn’t be investing like this when you’re a decade or less away from retirement because if you suffer a big loss, like the tech industry did during the dot-com crash of 2001, it may take a long time to build back up.
And you may just not have that amount of runway before you need to start drawing your assets down for retirement.
To get aggressive returns, you’re almost entirely exposed to stocks, and risky high growth stocks at that: technology companies, young high growth companies, emerging markets, etc.
You might have little to no exposure in other asset classes.
Unlike Level 4 where you still had 30% in fixed income and treasuries and marketable securities and cash, in Level 5, you might have 90% of your allocation in stocks, 10% in bonds, maybe 0% in treasuries and CDs and cash.
And even of your 90% in allocation in stocks, it’s probably largely weighted toward these higher growth investments in high growth sectors, but with higher risk and higher volatility: technology, emerging markets, high growth companies, etc.
So you can see the spectrum from Level 1 being defensive, where your stock exposure is maybe only 10%, to Level 5, aggressive, where your stock exposure is 90%, the curves essentially entirely invert along the spectrum.
So it is really helpful to ask yourself, what do you feel like your risk profile is, your risk tolerance is? And which one of these five levels do you think you best fit in?
Because that’s going to give you a really useful guide for how you might be thinking about your desired asset allocation.
Once you can be honest with yourself about what kind of investor you are, what your time horizon is for needing the money, and what your psychological risk tolerance is (these three different risk profile questions that I outlined over the last bit), then you have all the key inputs you need to construct a desired asset allocation.
You have the basis to say, “I know that what will give me my optimal balance of wanting to earn a good return, wanting to limit my risk, and wanting to have enough peace of mind that I’m not constantly worrying about what’s going to happen to my investments – that optimal balance for me, at this point in my life, is likely going to be…”
I’m making these up. These are fictional numbers, but just to give a sense.
“…are likely to be, say, 60% stocks, 30% fixed income bonds, 10% ultra safe cash, treasuries, CDs, marketable securities.”
Maybe within the 60% stocks, it’s 40 percentage points broadly diversified index funds like VTI, and 20 percentage points individual stock holdings of companies that you want to do your own research on and read about and invest in.
Maybe within your 30% bond allocation, it’s a mix of medium to investment grade corporate bonds. And within your 10% safe allocation, you have CDs, treasuries, maybe some muni bonds.
Whatever the construction of your desired portfolio is, the point is, first, try to construct your high level ideal portfolio by breaking down and deriving it from an honest assessment of your own investing style and risk tolerance.
Then populate into each breakdown slice what would actually go into that slice.
Is it index stock funds? Is it individual stocks? Is it individual bond holdings?
Is it index bond funds? Is it real estate, like REITs, muni bonds, treasuries, etc.?
You’re just trying to construct an ideal portfolio breakdown before you actually go pick the specific investments.
And part of this exercise is also trying to back into what return profile you’d be satisfied with.
Across your entire blended portfolio, what return do you need to hit for you to feel satisfied at the end of the day?
And notice I said “satisfied.” Not ecstatic, not euphoric.
You want to understand what is “good enough” for you. Because that is what you crucially have to understand in order to be disciplined in your investing.
Obviously, you’d be elated to have a sky-high return. It will feel like a windfall when that happens.
But if you know what return you need to hit to feel satisfied, then you can construct a desired asset allocation that will likely get you that return.
And then you can ask yourself, “Am I comfortable with the risk exposure I have to take to get that return”?
If you require, say, a 9% annualized return, then you can actually construct a prospective asset allocation for what your portfolio breakdown would likely have to be to get close to that.
For 9%, it will have to be pretty heavily weighted in stocks. That means it will be closer to a growth-oriented (or Level 4) risk tolerance.
And then you can honestly assess for yourself: “Am I comfortable with having, say, 70% of my portfolio exposed to stocks and only 30% to bonds and cash?”
“And of that 70% in stocks, am I comfortable with holding 20-30 percentage points in tech stocks or high growth stocks which are high growth but high volatility and high risk at the same time?”
I think if you walk away with one learning from today’s episode, it is this one: that the most crucial thing you need to be dead honest with yourself about is, what is your return expectation that will make you satisfied?
And what is the asset allocation you will likely need to achieve that? What is your comfort level with that asset allocation?
You want to try to calibrate your return expectation and the asset allocation needed to achieve it to be as close to your optimal comfort level, risk tolerance, time horizon, and investor profile type as possible.
That is the heart of creating good asset allocation and having extreme clarity on your desired asset allocation.
Now with that clarity on what your optimal or desired asset allocation is, the next step is to get a crisp understanding of exactly what your asset allocation is right now and to see how far your asset allocation has drifted from your desired allocation.
This part, thankfully, is straightforward to do. You literally go and record your asset allocation from your various brokerage accounts each month into a spreadsheet.
And then you calculate what the breakdown is and what the drift is compared to your desired allocation.
As I mentioned, I created a spreadsheet template for you to do exactly this yourself, which you can download from the show notes page for this episode at hackyourwealth.com/60. Definitely be sure to go grab that.
But to give you an overview of exactly how you would do it step by step, here is the process. You would:
1) Log into each of your accounts – all your bank accounts, all your taxable brokerage accounts, your tax-deferred accounts like 401(k)s and IRAs, your tax-free accounts like Roth IRAs, Roth 401(k)s, HSAs, etc.
2) For each account you would note what the individual investment holdings are and what the value is. You would record this into your spreadsheet.
3) You would then just do simple calculations to annotate each of the holdings, sum everything up, and calculate percentages to analyze the asset allocation percent to each type of account and each holding.
4) You would hold that up side by side with the same breakdown for your desired asset allocation.
5) You would then calculate the delta line by line to understand how big the drift is for each account and each type of account and each holding.
6) Finally, if it’s due for rebalancing, you would make buy and sell decisions to go and rebalance your accounts to get back to your desired asset allocation.
Now, one question that arises is: which accounts should you buy from and sell from? Because there might be tax implications in some accounts.
And how much should you buy and sell in each account to reach your overall aggregate desired asset allocation?
In general, it’s good to avoid tax consequences on rebalancing. You don’t want to have to pay a bunch of taxes inadvertently simply because you’re doing regular rebalancing of your portfolio.
You can do this through a variety of means. I’m just going to illustrate a few.
You could, first, don’t sell overweighted asset classes and, instead, simply buy underweighted asset classes to rebalance back to your desired allocation.
Similarly, if you contribute regularly, like through periodic paycheck deductions into a 401(k) or something like that, you could just allocate more incrementally to certain asset classes that are underweighted using your periodic contributions.
In that way, you would slowly amortize your way back up to your desired allocation.
If you decide you do need to sell some investments to get back to your desired allocation, you should consider selling only from your tax-advantaged accounts, like your tax-deferred accounts or your tax-free accounts.
That way, you won’t trigger tax consequences on the sale, and it will either be tax-free or you’ll just deal with the tax consequences much later.
Other things being equal, it’s usually a good idea to avoid selling from your taxable accounts.
You can buy in your taxable accounts without any tax consequences, but it’s generally a good idea not to sell because, obviously, you may trigger capital gains taxes.
And if you’re in a high income bracket, you may also trigger the additional net investment income tax, which is another 3.8% on top of 15-20% capital gains taxes.
However, there are, nevertheless, situations where it can make sense to sell from your taxable accounts.
One situation is if you actually have a loss and you plan to sell anyway as part of your portfolio rebalancing. If you plan to sell anyway, and you are selling at a loss, you can actually harvest those tax losses to offset against other gains elsewhere in your taxable portfolio.
Another situation is if you have an overriding need to exit an investment.
For example, maybe you hold a bunch of stock in a particular company, the value has appreciated a lot, you don’t own that stock in any other tax-advantaged account, and you now want to get out of it, for whatever reason.
Maybe you don’t agree with the company’s direction or strategy going forward. Maybe you just don’t want exposure to that company anymore because your investing thesis isn’t aligned with it anymore.
In this scenario, it could very well make sense to sell even if it means you’ll face a significant tax liability.
Because at the end of the day, it probably doesn’t really make sense to keep holding on to an investment that no longer aligns with your investing strategy simply to avoid paying taxes on it.
You could end up losing a lot more if that investment drops in value and you didn’t do anything about it when you could because you were trying to avoid a tax bill at the time.
Now, can you do some planning around the exact timing of the stock sale? Yes.
Can you structure the sale, like staggering the sale into different tranches spread out over a couple of calendar years, if it will help lower your tax bill? Of course.
You should be thoughtful about how to execute a stock sale to minimize taxes, but you should not let taxes dictate whether you sell at the end of the day. That’s the tail wagging the dog, so to speak.
One last situation I wanted to mention where it could make sense to dispose of stock out of your taxable account is when it comes to charitable giving.
Now, this here doesn’t actually involve a sale of stock at all. If you donate to charity, you can donate stock that has, for example, massively appreciated in value. And in doing so, you will avoid paying any capital gains taxes on that appreciation.
You still get the fair market value of the stock as a tax deduction, and you don’t have to pay any capital gains taxes on the appreciation.
Meanwhile, the charity gets the full value of the donation, and they also get a step up in basis to fair market value. So it’s literally win-win.
You rebalance out of a taxable asset without any tax consequences. You do good by donating a big chunk of stock to charity. And the charity gets a step up in basis on the stock.
By the way, this step up in basis also happens when you bequeath taxable stock to your heirs at death, as part of your estate distribution, assuming your estate value is under the federal estate tax thresholds, which are very high and which 99% of people will never hit.
But in that case, it’s less of a rebalancing maneuver since you have to die for it to happen, and therefore, it can only happen one time per life. It’s more of an estate planning maneuver.
But just to note that whenever you bequeath out appreciated stock that has a lot of capital gains in it, whether it’s as part of your estate transfer at death or when you give it away to charity, either way, you won’t have to pay capital gains taxes. The recipient will get a step up in basis to fair market value.
And in the case of charity, you also can feel good about it because you’re donating to a good cause.
Now, the last thing I wanted to hit upon before we wrap up here is how often you should rebalance your portfolio.
My general philosophy here is you should rebalance whenever your portfolio gets pretty far out of whack, or once a year, whichever is more frequent.
How far is considered “out of whack”?
There isn’t an exact science on this here, I’m going to admit. But my heuristic is, if any asset class you hold is more than 10 percentage points – not 10% but 10 percentage points – off your desired level, then it’s probably worth considering to rebalance.
And the greater it’s off that mark, the more risky it is not to rebalance.
Let’s say your allocation is 50% stocks, 30% bonds, and 20% treasuries.
Once each of those classes move more than a 10% swing in either direction, it’s probably worth considering to rebalance.
Again, if your allocation is 50% stocks, then if you’re currently less than 40% or greater than 60% stocks in your portfolio, it’s probably worth considering to rebalance.
Likewise, if your desired allocation is 30% bonds, but you’re currently at less than 20% bonds or more than 40% bonds, then it’s probably worth looking into rebalancing. And so on.
The farther you are away from your desired level, the riskier it is to do nothing, and so the more urgent it becomes to rebalance.
That’s it for today. I hope this was informative and useful in helping you get a big picture framework for how to think about asset allocation and portfolio rebalancing.
Again, we talked today about why it’s not only okay, but actually prudent to sell your winners and rebalance toward your underdog investments.
We also talked about how to think about and define your desired asset allocation.
We talked about how to track what your current asset allocation is right now, and how to analyze how far your asset allocation has drifted from your desired allocation.
We talked about the mechanics of how to rebalance your portfolio step by step, and some tips for how to do it tax-efficiently.
And finally, we talked about how often to rebalance your portfolio.
Remember to go download my bonus freebie for this episode, which you can get at hackyourwealth.com/60.
It’s a spreadsheet template that helps you calculate your current versus desired asset allocation and the amount of drift between the two. And it has chart visualizations for you to easily see all this.
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Kevin K says
Andrew, I heard Bill Bengen did some recent research where he learned that rebalancing is most favorable every 4-5 years. I think this is because historically market gains are typically multi year gains. From an asset growth standpoint he is willing to let his winners run, up to a point.
Andrew C. says
Interesting. Is there a link you could share/post here?
Andrew C. says
From Kevin: “Bengen discusses this in the recent Long View podcast 140 at the 25:25 point of a 40 minute interview. He believes too frequent rebalancing, including annually, will reduce returns and subsequent safe withdrawal rates. He recommended every 4-5 years based on his analysis.”