Portfolio allocation rebalancing

prohornblower · #1 12-30-2006, 07:53 PM

I keep hearing from our 401(k) "salesman", that it is essential to rebalance once or twice a year, which renders a 3% increase in overall yield.

I don't think this means a 10% annual return turns into a 13% return, but rather a 10.3% return.

Can someone explain how this works? I thought my future 401(k) contributions are all set as percentages anyway, regardless of what each fund does for the year.

Thanks.

ayamaguc · #2 12-30-2006, 10:55 PM

The data and conclusions are probably all crap, and I don't know if rebalancing improves returns, but it does help balance risk, which is the point of diversifying and investing in multiple instruments.

Think of it this way.. if you invest in 3 things for ex., and after year 1 investments A and B returned a small amount (say, 6%), and investment C returned 115%, then things are great, but you've got a problem-- investment C is now equal to about 50% of your portfolio and and A and B are only 25%. So you're probably overly levered to investment C.

Things tend to cycle back and forth (nothing goes straight up forever), so you can maintain balance by selling off some of investment C and buying more of A and B to get back to your chosen allocation (in this example 1/3, 1/3, 1/3).

You contributions can also be setup with separate proportions. This gets you dollar-cost-averaging through your regular contributions, which is another way to get your money in efficiently.

prohornblower · #3 12-31-2006, 01:06 AM

If your future allocations are always going to be 1/3, 1/3, and 1/3 I just don't see why it is so important to rebalance. Even if one goes way up, you are still purchasing 2/3 worth of future funds that have "underperformed", and are possibly bound to do well in the future.

Our plan salesman was making it sound like this was essential, and that we were all idiots if we don't do this twice a year.

stinkypete · #4 12-31-2006, 08:19 AM

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Our plan salesman was making it sound like this was essential, and that we were all idiots if we don't do this twice a year.

[/ QUOTE ]

he probably makes a commission every time you sell/buy something. you probably shouldn't be dealing with him.

are these no load funds? do you pay a commission when you sell one fund and buy another? it actually lowers your expected return if it costs you anything.

gull · #5 12-31-2006, 08:51 AM

Rebalancing isn't that critical. The whole point is to manage risk (and thus maximize your risk-adjusted return). An easy way to keep your asset allocation constant is to just put all of your new investment dollars into your underrepresented funds.

For example, figure that you can tolerate the risk from a 70/30 stock/bond portfolio. Pretend you don't touch that portfolio, or keep depositing new dollars at a 70/30 ratio. Stocks have historically returned more than bonds, so it's very possible that at the end of a year you actually have an 80/20 stock-bond ratio. Since you've determined this to be too risky, it's a good idea to rebalance so you don't take any unwanted and unnecessary risk.

prohornblower · #6 12-31-2006, 12:52 PM

[ QUOTE ]
[ QUOTE ]

Our plan salesman was making it sound like this was essential, and that we were all idiots if we don't do this twice a year.

[/ QUOTE ]

he probably makes a commission every time you sell/buy something. you probably shouldn't be dealing with him.

are these no load funds? do you pay a commission when you sell one fund and buy another? it actually lowers your expected return if it costs you anything.

[/ QUOTE ]

I'm not really sure. I've only sold and bought once since my inception (bought an int'l fund). I didn't notice a load, but I guess it could have been hidden somehow. It's a 401(k), so it's "user-friendly" and kind of cloudy. I do know that my co-worker buddy researched the funds in our plan and found them to have, on average, 1.45% expense ratios. lol.

ayamaguc · #7 12-31-2006, 06:09 PM

[ QUOTE ]
If your future allocations are always going to be 1/3, 1/3, and 1/3 I just don't see why it is so important to rebalance. Even if one goes way up, you are still purchasing 2/3 worth of future funds that have "underperformed", and are possibly bound to do well in the future.

[/ QUOTE ]

What's the disclaimer that's always in the fine print?
"Past performance is no guarantee of future results." sayth Google.

If you knew what returns would be for something in advance XX into the future, then all the ideas in personal investment finance (allocation, diversification, dollar cost averaging, etc.) would be irrelevant, right? You just figure out your goal date for the funds, figure out what will return the absolute most by your date, and stick all your funds there.

Well, we don't know the future with certainty (I don't anyways), so take steps to mitigate risk. At no point are you bound to do well. You may do well. You may do poorly.

When you're first starting out, your paycheck contributions may be significant as a percentage of your total, so the beneficial effects of averaging may help you with balancing, but that will (hopefully) change before too long.

The above poster's point about commissions and charges is certainly a good one. 2x/year is too often and too much work. But annually? Maybe. 18 months or 24 months, ok.

Just eyeball things. Keep your contributions and allocations in sync with your plans and goals as you go forward. Etc.