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Is It Time To Rebalance Your Portfolio?
Tuesday Apr 08, 2011
Andrew Tobias

[The information in this column previously appeared in Andrew Tobias - Money and Other Subjects, and is used with the kind permission of the author.]

"While listening for the umpteenth time about the necessity of periodically rebalancing one's portfolio, I was struck by the thought that rebalancing essentially means taking winnings out of your investments that have done the best and putting them into those that have done the worst.  Put in those terms, it seems, if nothing else, counterintuitive.  What say you? - Artie  Doskow

Andrew Tobias responds:

I say: good question, but I’d definitely go with David Swensen* (and everybody else) on this, for two reasons.

First, it’s "buy low, sell high."  Right?  (Nothing counterintuitive about that.)  When an asset class rises in value, you trim it back (selling some high) to beef up your holdings in other asset classes (that are now, relatively, low).  It’s a mechanical discipline, like dollar-cost averaging, that over a lifetime tilts the odds in your favor.  (It doesn’t work as well in a taxable account; but in a retirement plan, the only thing to watch out for are the transactional costs of switching money around.  Which is why index funds under the Vanguard umbrella, say, make sense.)

Second, it is asset classes we’re talking about here, not individual stocks.  With stocks, a good rule of thumb – or at least a rule of thumb to consider, especially in a taxable account – is to "cut your losses and let your winners ride."  With asset classes . . . like "U.S. Equities" or "International Equities" or "Cash" or "Long-Term Bonds" or "Real Estate Investment Trusts" or "Commodity Funds" ... it’s unlikely that the relative advantage of one asset class will just keep gapping ever wider for decades relative to the others (or that an entire asset class would ever become entirely worthless as a stock might).

For whatever reason you decided that you wanted (say) 35% of your assets in U.S. stocks at this stage of your life, why would you increase that percentage as U.S. stocks became relatively more expensive?  ("Hey, Marge!  Prices are up across the board – let’s go shopping!") You wouldn’t.  So if you notice that the 35% slice of your pie that was in U.S. stocks is now, because of good gains in the market, 40%, you would sell enough (selling high) to bring U.S. stocks down to the 35% you intended.

By the same token, why would you decrease your intended percentage as U.S. stocks got cheaper?   ("Hey, Marge!  There’s a clearance sale at the mall!  Let’s avoid it!")  You wouldn’t.  So if you notice that the 35% slice of your pie that was in U.S. stocks is now 30%, you’d switch some assets out of your other asset classes to buy enough stock (buying low) to restore the balance of your portfolio.

This is not nearly as much fun as speculating on Borealis or Aldabra warrants, but a significantly more prudent life plan.

*David Swensen's advice: diversify, keep your transaction costs low (mainly through index funds), and "rebalance" periodically, especially within retirement plans, where there’s no tax cost to doing so.  

Andrew Tobias is the author of a number of bestselling books including  and "Managing Your Money," the leading computer software in the field of personal finance'. He is a contributor to the New York Times Sunday Magazine and is a graduate of Harvard College and Harvard Business School.  He is also the treasurer of the Democratic National Committee.