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Friday, March 24, 2006

Rebalancing a Portfolio is hard...

So I finally sat down and systematically rebalanced my portfolio. From when I started to when I finished was about one and a half hours. My primary tools were Vanguard's web-site and Excel (any spreadsheet will do, but when you copy and paste a table from a web browser into Excel, it does the right thing and numbers stay numbers, which is very important for fast imports).

Vanguard offers a unified account consolidation view (including all your bank accounts, savings accounts etc), so when I selected and pasted that into Excel, I got all my financial data in one easy place (I don't trust my quicken accounts, since it's not completely up to date). I then create a table with my ideal asset allocation (I use the table provided at The Retire Early Home Page to set up my allocations).

After that, it's a matter of systematically assigning allocations to my existing investments, and adding up all my assets. (Don't forget to subtract your liabilities!) Then you figure out how far each asset class deviates from your ideal, and rebalance. In my case, there were a few items I didn't want to touch, so I over-rode my ideal allocation and went with something less than ideal (isn't that life?). For each asset class, you might want to sub-divide the allocation. (For instance, for domestic stocks, you might want to divide into small cap/mid cap/large cap, or for maximum convenience just use a "Total Stock Market Index")

Then another visit to the Vanguard web-site to perform the asset re-allocation.

A few things to watch out for:
  1. When allocating assets, if possible move stuff around in retirement accounts for the rebalancing. That allows your rebalancing to be tax-free to the largest extent possible.
  2. Consider the size of the re-allocation. If it's large enough, ETFs might make more sense than index funds. If it's too small, then mutual funds are more efficient.
  3. If you're going to take a loss from a re-allocation, depending on your circumstance, it might make sense to try to make it a long term loss rather than a short term loss, or vice-versa. (one tax management trick I've done in the past is to harvest a loss by exchanging one fund for another fund of the same asset class, thus staying invested while getting a capital loss for tax purposes --- but obviously, that's not as good as having lots of capital gains everywhere in your portfolio!) Note that such tax tricks are better off done closer to the end of the year when your overall tax picture is closer.
  4. Your tax situation should only dictate which particular vehicles you want to use for your asset classes, not which asset classes you want to be in.
How often should you rebalance? Well, if you're David Swensen managing the Yale endowment portfolio, every day! If you're the typical individual investor, then once a year is what's typically recommended. Of course, your circumstances can vary!

Interestingly enough, if Vanguard is your employer's 401(k) manager, the on-line tool gives you a one-button rebalancing option (it rebalances to your 401(k) new money allocation, which is what you want if the 401(k) is your primary investment asset). That's very nice, but can't take into account your overall financial situation. Nevertheless, for those whose primary investment assets are in their 401(k) and are lucky enough to have Vanguard as the 401(k) trustee, it's a very nice button. Just push it and you're done! No spread-sheets, no tax consequences, and no hard thinking.


ShakenNotStirred said...

I an new to investing and was wondering if anyone had any suggestions about education? I've read The Intelligent Investor by Ben Grahm, subscribed to and looked at but haven't subscribed. It just seems like there is to much information out there and I don't know what the best way is to proceed. Any help would be great.

posted by John Davis

ShakenNotStirred said...


Unknown said...

You are best off reading The Wall Street Self-Defense Manual. After that, you'll be in a good position to figure out where you want to go.

Achayan said...

Another great book is The Bogleheads Guide to investing