Am I making a mistake by not rebalancing my portfolio?

Balanced rocksPhoto courtesy of synx508

I believe that investing is a crucial step in your plan to become financially secure. So I recommend putting as much as you can into an investment portfolio like a 401(k) at work, or (especially) a Roth IRA that you create yourself. 15% of your pay is a good round number.

But allocating money is only the first step. Once the money is in there you have many options on what to invest the money in.

Those who recommend these things recommend a mix of stocks and bonds (which remember can all be in mutual funds; you’re not picking individual stocks here). The most famous of these adages says something along the lines of “own your age in bonds“. So if you’re 30 years old, you should own 30% of your portfolio in bonds.

Personally, I think that’s garbage advice. We need all the growth we can get, and bonds just ain’t gonna cut it.

Regardless of what allocation you’ve decided on, one suggestion that everyone seems to make is to rebalance your portfolio periodically.

I’m not doing this. I haven’t rebalanced pretty much ever. Am I making a mistake?

A rebalancing example

To understand rebalancing, let’s see an example.

You have $100,000 in your account. You have 70% in stocks and 30% in bonds. So you have $70,000 stocks and $30,000 bonds.

Over the next year, your stocks returned 8% and your bonds returned 3%. So at the end of the year, you have $75,600 in stocks and $30,900 in bonds.

With these new returns, your percentages are now 71% and 29%.

Okay, not much difference. But over time, if this keeps happening, you could have percentages that are far off your original targets.

Why rebalance?

Rebalancing your portfolio is the act of returning your portfolio allocations back to your desired levels. This might mean selling some stocks (within your portfolio) and using that money to buy bonds, or vice versa, depending on how the markets move.

This task is purely a defensive maneuver. It minimizes risk, rather than maximizing gains.

I’m a naturally risk-averse person. So why am I not doing this?

We must be risky in investments

I don’t believe that we have the luxury to be conservative when it comes to investments. The average return of the stock market is around 8% over the long term. (Inflation will eat some of that up.) The long term average of bonds is much less. Yes, theoretically bonds are supposed to rise when stocks fall, but, again, if you take into account the long term, this doesn’t matter.

I don’t believe that risk-free investing exists. And yes, it’s possible that the stock market could go into a tailspin and never recover. That has never happened before though. And if it does, we’ll have bigger problems to worry about than retirement.

If you got out of the stock market in 2008 or 2009, you would have lost out on all of the amazing gains of the next few years. But if you stayed solid throughout, you came out ahead. Well ahead. The Vanguard Total Stock Market Index (VTSAX) returned 7.69% annual returns over the past 10 years, a period of time that included the biggest recession in our lifetime.

VTSAX performance

Returns of the Vanguard Total Stock Market Index Fund

The only exception to this is if your retirement age is getting close. Then you might not be able to ride out a long recession like the one we just had. In which case, minimizing risk becomes more important.

But I’m not there. Yet.

So for the moment, I am going long on stocks, and not worrying if my allocations there grow faster than my bonds. We need stock’s potential for long term growth.

Rebalancing feels too much like market timing

When you rebalance can affect your returns. If you rebalance more often, you’ll get a different result than if you rebalance once in a while.

To me, that smacks of market timing. And you cannot time the markets. You will lose.

The only exception to this rule is if you have a target deviation, not a target time frame. Meaning, you don’t have any specified time frame for rebalancing (monthly/yearly/etc.) but instead wait until your portfolio is a certain percentage off. Like in the example above, waiting until stocks become 75% or 65% instead of 70%.

It doesn’t seem worth it

In the example above, in the course of one year, an average return changed the allocation by 1%. Big whoop.

Perhaps it’s because my exposure to bonds is so small to begin with, but it’s going take years for there to be a big deviation enough to make rebalancing worthwhile.

Okay, in 2013, we had such a year, something like 30% gains in the stock market, and a negative bond return. But that’s not an average year.

Focus on regular investing, not regular rebalancing

Rebalancing may or may not be important, but rebalancing is not nearly as important as regular, sustained investing.

If you’re not to the point where you’re investing real money (up to 15%), then I don’t think it matters whether you’re rebalancing or not. After all, if you don’t have anything, then you don’t have anything to lose.

So I continue to invest every month in my “unbalanced” portfolio. And I’m okay with that.

I’m not going to suggest that you don’t rebalance either. But if you’re going to rebalance, you need to have a good reason for it, not just “the experts told me to“. Know your goals, do the math, and only then make the call.

But enough about me. Do you rebalance your portfolio? How do you do it? Do you think I’m making a mistake by not rebalancing?

Mike Pumphrey

Mike Pumphrey

I'm the founder and author of Unlikely Radical, a site to help people succeed with money, achieve their goals, and live intentionally.

I offer a free phone consultation to anyone who is interested in changing their financial narrative. Are you ready? Click here for details.
Mike Pumphrey
Posted on April 24, 2017