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Rule of Thumb: When should I rebalance my portfolio?

September 9, 2011 - 0 comments

Vanguard researchers have determined in a recent paper that historically, rebalancing only once or twice a year, and only when the portfolio’s asset-allocation target is off by at least 5%, is probably good enough for most investors. 

Larry Swedroe, in his book, “The Only Guide You’ll Ever Need for the Right Financial Plan,” discusses the 5/25 rebalancing rule.  In the 5/25 rule, your portfolio is only rebalanced if an asset class wanders either plus or minus 5% from the original asset-allocation target, or plus or minus 25% of the original asset-allocation target (whichever one is less).

To further illustrate this concept, I’ve included a sample target allocation for a balanced portfolio in Table 1 below, followed by acceptable overweights and underweights, using both the 5% and the 25% rule.  The lower absolute amounts using either the 5% or 25% rule for each asset class (highlighted in light blue) are then added and subtracted from each target allocation to determine the maximum and minimum asset class thresholds.

In Table 2 below, a sample rebalancing table is shown, with the target allocations, as well as the minimum and maximum asset class thresholds.  Investors can create a personalized rebalancing table in order to bring greater discipline to their rebalancing schedule.    

As with any rule, there will always be exceptions.  However, creating a rebalancing table is just one more step that investors can easily take that will encourage a more systematic and unemotional investment process.

By: Justin Bender with 0 comments.
Filed under: Portfolio Management
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