In a Rocky Market, When to Rebalance?


If daily market swings are knocking your portfolio out of whack, should you fix it sooner, rather than later?

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Smart investors have long understood the value of rebalancing — bringing their mix of stocks, bonds and other assets back in line on a regular basis. But when the markets threaten to throw that mix out of whack on a daily basis, what's an avowed rebalancer to do?

Less than you might think. Big moves in the market don't necessarily translate to big moves in a portfolio, and chasing daily movements — even in the name of a long-term strategy — may defeat the purpose, says Maria Bruno, an analyst in Vanguard's investment counseling and research group. Depending on the account, you could rack up transaction costs that will eat away at returns, and not only that, you'll make yourself crazy. "You're really just chasing the market in a circle," Bruno says.

The idea behind rebalancing is simple: If you never rebalance, over the long term your higher-performing, higher-risk investments, typically stocks, will become a bigger and bigger piece of your portfolio. Because stocks are more risky, "you end up with a more aggressive allocation than you wanted," says Maria Bruno, an analyst in Vanguard's investment counseling and research group. That may make for slightly better performance over the long term, but also far more agita. Between 1926 and 2009, a never-rebalanced portfolio of 60% stocks, 40% bonds would have eventually been fully exposed to annual stock market performance ranging from up 54% to down 43%, with losses every four years on average.

To avoid these ups and downs, advisers typically recommend rebalancing on some kind of schedule, no more than once a month — or when allocations stray more than five percentage points from their targets. It's the latter rule of thumb that makes investors pay attention when the market swings. But it takes a really big move in the markets to throw a portfolio that far off course in a short period of time. In a portfolio with 60% in stocks, 40% in bonds, a 5% stock market drop would still leave 58.8% of the portfolio in stocks. To push the portfolio into rebalancing territory — 5 percentage points off target — it would take a 19% drop in stocks (assuming that stock investments move in lockstep with major market indexes, and bond investments are flat).

To be sure, the pros take a slightly different tack. The team that run's T. Rowe Price's retirement-date funds, which hold stocks, bonds and other investments, aims to stay within one-half of one percentage point of their target asset allocation, and the team uses cash flows to stay on track, putting new money into cheaper assets, says Jerome Clark, a portfolio manager for the funds. Given that they're managing $65 billion, even a small shift represents a lot of money they'll have to move around, Clark says. Rebalancing as aggressively would be too much of a hassle for most investors, and rack up transaction costs for those with brokerage accounts, but the idea of using new money to rebalance is a good one, says Christine Benz, the director of personal finance at Morningstar. Instead of selling bonds to buy stocks, for example, leave the bonds alone, and use new contributions to boost the equities stake.

There's also a less obvious problem with a true rebalancing discipline, Bruno says: It's hard to sell assets that have done well in favor of those that have not. Investors who rebalance this month, for example, would probably be shifting money into stocks — a move that, in this environment, requires a strong stomach. "When the stock market is doing well, you're not going to like the idea of selling," says Ethan Anderson, a senior portfolio manager with Rehmann Financial. "And on a day like Thursday, you're not going to like the idea of buying." If you really can't sleep at night, it's O.K. to take a little money out of the stock market, Anderson says. Just don't make any big strategic changes until the market settles down, cautions Clark. "Investors are almost guaranteed to do the wrong thing if they do it in the midst of extreme market moves," he says.


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