How to Rebalance your Portfolio for Free using Personal Capital – Ultimate 2018 Guide

You’ve done a great job creating a strategic portfolio allocation. Great job!

 

You know exactly what percentage of stocks, bonds, REITs, and cash to hold in your portfolio.

 

It’s perfect. Just perfect. You think you’re done. Turn off your computer and walk away for 30 years, just to come back to your account and see your account just the way you had left it (but worth significantly more!)

 

This obviously is not going to happen. Over time, your portfolio will get bent and twisted out of shape. And as a smart investor, it’s going to be up to you to get it back to how it belongs so you can watch it grow, while under control.

 

That’s the topic of today’s post: Portfolio Rebalancing.

 

Whether you’re an advanced investor or just beginning, it’s important that we all get on the same page about what it means to rebalance a portfolio before we dive into the tactics of implementing it on your portfolio. But before we can talk about rebalancing, we need to cover the basics of portfolio drift.

 

So let’s begin!

 

What is portfolio drift, and how can it damage your portfolio over time?

Every moment of every trading day, your investments are changing price. Some are going up, others are crashing. That’s the beauty of diversification. But the downside here is that when one asset goes up and another goes down, your overall asset allocation is getting bent out of shape.

 

Portfolio drift cannot be avoided. It is part of investing in the markets. And even though from an investor perspective it can seem that portfolio drift is a bad thing – some enemy of the investing process – that couldn’t be farther from the truth.

 

As we will find out in this article, portfolio drift can become one of our greatest assets in the investment world if it is managed properly.

 

However, without being monitored and managed, portfolio drift can put you at significantly greater risk with your portfolio. You can become more susceptible to draw downs, less diversified than you intended, and overall with a less than optimal portfolio to grow over time.

 

What does it mean to rebalance your portfolio, and why should you do it?

Rebalancing in general is bringing things back into equilibrium – back to its original desired positioning. When you create your strategic asset allocation, you are doing that for several reasons that I cover in a separate post. But at a high level, you want to manage your expected return, volatility, and ability to withstand portfolio drawdowns.

 

This is an incredibly important part of the long term investing process. It provides a “north star” to your decisions, allowing you to put your investments on an auto-pilot course, while knowing that the hard work has already been done to make sure your investments are right for you and your risk tolerance.

 

But as we covered above, portfolio drift is always working to pull that allocation out of balance. Let’s look at a simple example.

 

When you first set up your strategic asset allocation, you select the classic 60% US Stocks, 40% US Bonds. After an incredible year, stocks run up 25%, while bonds only mildly increase. When you look at your statement again, you’ll see a change in the overall allocation:

You may be thinking, “It’s only a 5% drift, what’s the big deal?” And you may indeed be right.

 

Much like your initial asset allocation, portfolio drift and determining when to rebalance your portfolio is a very personal decision.

 

In order to rebalance this portfolio, you would be forced to sell a portion of your stocks and buy up more of the bonds to return you to your original 60/40 allocation. This forces you to “buy low and sell high,” a common adage in successful long term investing.

 

But this can be a challenge to do, because stocks just had a monster run up! Why would you want to sell now when there could be another 25% year in store?

 

We will get into the mindset in a moment, but first I want to discuss some of the popular techniques to portfolio rebalancing.

 

The 5 techniques to portfolio rebalancing

1. Never rebalancing

Yes, this is indeed an option, but not one I recommend! In your 401(k) or any of your investment accounts, you can set up your schedule of deposits, and determine how much to put into each ETF or mutual fund.

 

So for the allocation in the example above, you could automatically deposit 60% of your paycheck contribution to US Stocks, and 40% to US Bonds.

 

This is certainly not ideal, as the drift could continue to compound significantly over time, shifting your risk tolerance beyond what you intended.

 

2. Only when your risk tolerance changes

This is slightly better than never, but better options definitely exist. Over time your risk tolerance will change, especially if you are following your path to financial independence.

 

As you start out accumulating assets, you may be 90-100% stocks, and after your claim your independence, you would likely transition into a larger bond / cash position to reduce your volatility.

 

Setting and forgetting has its benefits, so this option is for those who really don’t want to be bothered with their portfolio until something drastic in their lives have changed.

 

3. On your birthday

This is a common recommendation, and for good reason. Many studies have shown that the more often you check your portfolio, the less money you end up making. This is due to the investor wanting to tinker with their portfolio, or to sell out because they see something scary when they log in.

 

The birthday method of rebalancing helps to avoid this. The idea is that you set your allocation once a year, and try your best to completely ignore it for until your next birthday.

 

This has the benefit of being simple and easy to remember. It also allows you to consider your tax situation on a yearly basis so you can have a built-in timer for looking for tax loss harvesting opportunities.

 

There are also some downsides to this method. For example, your 401(k) may not have all the asset classes available for you to invest in. Many do not have good, low cost options for REITs, international bonds, or other alternatives. You would probably need to fill that allocation with IRAs or other accounts that have more options.

 

But here’s the rub. If you front load your IRA in January, but are forced to contribute to your 401(k) every paycheck, you will be allocating to each of your asset classes at a different rate, and keeping it in balance can be a challenge.

 

So when you reach your birthday, you could face a signficantly out of sync portfolio, and may need to make significant buy/sell decisions to bring it back in line. This is not a major concern over the long haul in terms of risk/reward, but it is something to consider based on your risk tolerance.

 

4. Using drift tolerance bands

Drift tolerance sounds like a fancy term, but it’s very simple in practice. Drift tolerance sets pre-determined limits above and below your target allocation that you will “tolerate” your portfolio to drift within, before deciding to take action and rebalance.

 

Let’s look at an example.

 

Let’s say you maintain the 60/40 portfolio from above. You could set a +/- 5% drift tolerance to your asset classes. This means that you would let your US Stocks position drop down to 55%, or rise up to 65% before you would consider rebalancing the portfolio.

 

This brings the benefit of “letting your winners run,” to a defined degree. This way, when your system requires you to rebalance, you are getting a slight boost in performance from selling the winner and buying the loser.

Source: Global Financial Data

The greatest challenge with this method is knowing your overall asset allocation to figure out exactly when your portfolio has drifted to the required amount. Luckily we will be discussing tools to make this easier in just a little bit.

 

5. Every time you add or remove money

This is where things get a little bit complicated. Instead of using drift tolerance, what if every time you made a transaction, your portfolio tries to keep you properly balanced? If every time you added money, you only added it to the asset class that was most underperforming? If every time you withdrew money from the account, it only withdrew from the asset class that had outperformed?

 

This is how many robo-advisors like Betterment and Wealthfront operate, and is really where software automation shine. But does such micro-management of your allocation really add to the bottom line?

 

In Meb Faber’s book, “Global Asset Allocation,” he examines just this and determined that monthly rebalancing of his global portfolio amounted to less than 0.5% boost in annual returns! Any increase in performance is good, but it makes you realize that adding more time and effort into your portfolio may not be the best use of your time.

 

Additionally, rebalancing too frequently could cause unintended slippage effects. If you are constantly buying and selling your positions to keep in perfect symmetry, you are incurring costs on each end of the transaction, which will dampen the effects of the rebalance.

 

So find your preferred method and stick with it, knowing that some form of regular rebalancing can improve your long term results.

 

What is the best time of year to rebalance your portfolio?

Here at Nine to FI, we are always looking for the best way of doing everything. So the natural question comes up, “What is the best time of year to rebalance your portfolio?” I get it.

 

Just like the technique of rebalancing, there are several options when it comes to timing:

 

1. Towards the end of the year

A common time frame is to rebalance towards the end of December, as this allows you to make one final assessment on your tax situation for any opportunities before the end of the year.

 

But this is also around the holidays, which generally means the markets will be a bit calmer with less volume. If you invest in ETFs with lower volume, you’ll want to make sure you don’t lose much in the bid/ask spread by using limit orders when placing your trades.

 

2. Around a memorable date

Checking your portfolio on Christmas may not be your cup of tea – I understand! You can have equally good results by picking any memorable date of the year (hint: birthday?) to do this same process.

 

3. Just after a major market move

We all know that timing the market is for fools, but if you have set a portfolio drift tolerance, you can still get away with it!

 

This bull market hasn’t given us a ton of opportunities in the last few years to implement this, but if we look back in time – major market shocks can be a good time for rebalancing:

 

The volatility we had in mid 2015 and early 2016 would have probably knocked your portfolio out of alignment.

 

And if you remember back to that time, there was nothing but gloom and doom on CNBC – recommendations that the next bear market was knocking on our doorstep.

 

All the advice in the media was to sell, sell, sell. But with your strategic asset allocation, to stay true you would need to have bought in during these lows.

 

How a systematic rebalancing software can save you thousands of dollars

 

Your greatest enemy in this entire process is your mindset. In “Thinking Fast and Slow,” by Daniel Kahneman, he discusses at great length the many cognitive biases that are constantly trying to undermine our investment success.

Thinking Fast and Slow Portfolio Rebalance

This is required reading for any investor

So how do we defeat our biases once and for all? By following a plan that we commit to. Any of the techniques and strategies above are suitable to keeping your mindset in check.

 

But can it really save you thousands of dollars? I believe it can for a few reasons.

 

Saving on fees

Creating your own asset allocation of low cost index funds can save you a ton of money in fees over time. You can skip this whole rebalancing process by purchasing funds that do the work for you, but it comes at a cost – an expense ratio more than 3 times the cost of doing it manually:

A 0.14% expense ratio is still dirt cheap, so this can also be a viable option if you don’t have the confidence in managing this by yourself. But consider the savings over a 30+ year time horizon!

 

Preventing poor, subjective timing decisions

Humans have evolved to run from pain, fear the unknown, and to feast when food was available. It’s how we survived for thousands of years.

 

These traits make us good survivors, hunters, and gatherers. But they make us absolutely terrible investors.

 

 

Consider the recent trends of everyone’s favorite buzzword – Bitcoin.

 

As the cryptocurrency began making its meteoric rise, more and more speculators rushed in to scoop up on the trend.

 

It seemed the only place for this asset class go go is up! Right?

 

As the price shot up, you started to notice something on the internet – more gurus offering you expensive online courses to help you make the most of your bitcoin investing. Ads in your Facebook feed of marketers trying to explain what it all means.

 

All this to help pile on more and more buyers.

 

No financial advisor that I know recommends a strategic asset allocation to cryptocurrency. As a result, any buying of this class is purely to attempt to time the market and catch a flying trend. And as the price goes up, the desire to purchase rises with it to its peak.

 

As soon as a news story or government regulation gets put into place, the selling begins. And because you once again did not have a systematic investment process in place, you are faced to decide to keep or sell based on emotion, gut feeling, or general gambling.

 

And as analyzed in “Thinking Fast and Slow,” the experience of pain is greatly magnified when we experience financial loss. This generally leads to following the herd mentality and selling at the wrong time as well.

 

Not a good way to build long term wealth.

 

What is the best portfolio tracking software if you have multiple investment accounts?

If you only have 1 investment account, it is simple to understand what your current allocation is and what you would need to do to rebalance the portfolio.

 

But here at Nine to FI, we believe that you should look for any opportunity to save on taxes and maximize our long term growth through multiple investment accounts, such as

  • 401(k)
  • Traditional IRA
  • Roth IRA
  • HSA
  • Regular Brokerage

When you start adding complexity to your accounts like this, it becomes important to use portfolio tracking software to keep your finger on the pulse of your portfolio.

 

And in my opinion, there is no better free software out there than Personal Capital. You can read the full review here.

personal capital investment portfolio manager

 

Why Personal Capital is the best investment management software for individuals

Personal Capital is the Swiss army knife for the personal finance crowd like us. From a single website, you can see every transaction you made from any account, as well as the account balance and portfolio allocation of your entire investment portfolio:

Portfolio Drift Personal capital

 

 

But it doesn’t stop there – based on a few questions it asks you about your risk profile, Personal Capital actually recommends a portfolio allocation for you, called your “Target Allocation.”

Now you can choose to listen to this allocation, or you could just do whatever you want. It’s your money! But one of the main takeaways I took from Meb Faber’s “Global Asset Allocation,” is that regardless of exactly how you tweak your asset allocation, the results tend to cluster together over time. It really doesn’t matter, so long as you remain disciplined to that allocation over time:

Investment Portfolio Strategies

Source: Mebane Faber, Global Asset Allocation, and Global Financial Data

The graphic above shows a 40 year analysis for 8 very different investment allocations. And while you can see that each one had different ups and downs throughout the year, they all ended up in roughly the same spot.

 

So whether you choose to use Personal Capital’s allocation or create your own, just commit to it long term.

 

I have chosen to adopt Personal Capital’s portfolio recommendation, because I like to tinker with my investments probably more than I should, so having a very explicit portfolio that doesn’t change its allocation is a good thing for me.

 

Additionally, Personal Capital provides its own recommendations of when your portfolio drift has gotten to severe, and makes recommendations to rebalance:

 

The downside here, is that it doesn’t tell you exactly how many shares you’ll need to sell or buy to achieve rebalance – that is mental math you would still need to do. But keep reading, I’ve made that process simple too!

 

Can I use a spreadsheet to track my stock portfolio?

Google sheets is a powerful free spreadsheet program, and when you combine Personal Capital with google sheets, you can have some incredible control over your portfolio.

 

Before Google Sheets, you would need to copy and paste the current price of each of the tickers in your portfolio, and try to figure out exactly how many shares to purchase to get yourself back in balance.

 

But now, Google sheets is able to tie the current stock price directly into the program, so there is no longer any updating needed by you!

 

While this sounds like a small deal, let’s take a closer look at how this can make you a better investor.

 

A real world example of rebalancing a portfolio

In the example above, the investor has entered the current value of his overall portfolio and the % in each asset class into the yellow cells. This info comes straight out of Personal Capital.

 

The target allocation cells can be whatever your overall allocation strategy is, but in this example it mirrors the “Growth” allocation from Personal Capital.

 

Finally, the Ticker symbols are the low-cost Fidelity tickers that have been selected to address each of the major asset classes. These can be customized for the investor’s preference, but should be kept to simple, low cost index funds that focus solely on the specific asset class.

 

From here, the spreadsheet goes to work to determine the current price of each ticker symbol, as well as exactly how far out of balance each is, to eventually recommending the number of shares to be purchased / sold to get back to balance!

 

To show the flexibility of the tool, let’s say the investor does not want to use FREL (a real estate investment trust) for his alternative, and instead likes GLD (a gold etf):

Now instead of needing to purchase 800 shares of FREL, you would only need to purchase 150 shares of GLD to achieve balance. This is because of the price difference between the ETFs.

 

How a portfolio rebalancing tool can make the process so much easier

The tool above has only 1 purpose: to make it as easy as possible to stay systematic in your rebalancing efforts.

 

The goal is to get in, analyze your portfolio, make the changes, and get out as quickly as possible!

 

The less decisions you have to make and the more you can automate in the process the better.

 

Keep your fees low, your time staring at your portfolio low, and you will find success in wealth and in life.

 

So how has your portfolio drifted?

Is it time for you to rebalance your portfolio? I hope you download my free tool and use it to save you time, fees, and stress as you continue to manage your growing wealth over time!

 

Leave a comment below!

About the Author Jack

Hey there, I'm Jack - husband, father, and financial independence seeker. I started Nine to FI with the goal of helping a million professionals build a life of purpose and freedom. I'd love to hear from you and where you are at on your own journey!

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Broke College Kid to 30 Year Old Millionaire

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