The market is way up. My net worth is way up. I changed my asset allocation. Now it’s time for a new rebalance strategy.
Before we get started, credit where it is due. A recent post by Mr. 39 Months inspired this one. I have been quite busy, hence the lack of recent updates. But sometimes a topic on someone else’s site hits me hard enough that I just have to write something.
Our Historical Rebalance Strategy
In the past I have written about our rebalance strategy. In essence for most of the life of this blog, and before, I have used new contributions as my rebalance strategy. Essentially I’d adjust where I placed my new contributions about once a quarter to slowly bring my asset allocation back into my desired balance across accounts. Over the course of that quarter things inevitably corrected within a reasonable tolerance level.
This rebalance strategy has served me very well over the years. It has no transactional cost and when you are early or even mid financial journey it can very quickly bring things back into balance. With the stock market mostly going up over this period with moderate volatility the benefits of this approach were magnified. I would not hesitate to recommend this to any one in this stage of investing.
A Different Financial Stage of Life
But somewhere in the last few years I exited that stage. My annual savings rate still equates to two years of income, but 2 years is not what it use to be. Our net worth is now near 40x pre retirement spending. In other words my contributions for the entire year represent just 5% of my net worth, and falling.
Add to the above my recent struggles with burnout, which are leading to a reconsidering of my retire at 55 date. While I haven’t made any definitive decisions on that retirement date, I did recently change my asset allocation to 25% safer assets. As part of that readjustment I also changed my rebalance strategy when I updated my investment plan.
A Crash and Quick Return As an Investment Opportunity
Given the stock market has moved double digits most of the last 5 years, a 5% swing due to contributions is not going to keep our allocation aligned. Also, last year’s quick crash and recovery from Covid, lasting only about a month and a half, showed that my contributions could not adjust in a manner in line with the market moves. The reality is, while I don’t believe in dry powder, I do realize that rebalancing into a significantly down market in a planned method can lead to a massive upside when things recover. I missed most of that last year.
So I needed a rebalance strategy that could allow me to rebalance in response to a massive quick change in the stock market. But conversely, there is a lot of evidence that too much rebalancing is bad for long term outcomes. This can be due to transactional costs but also because it undermines momentum (the tendency for stocks to continue to move in a similar direction for a period of time).
Two Rebalance Strategies
So the two strategies I considered were to just rebalance on a periodic calendar, or to do it based on how far my allocation drifted from my target. Ultimately I decided the periodic calendar approach was too arbitrary for me. Also given that last down turn lasted just a month and a half, it wouldn’t allow me to capture some potential buying opportunities.
So instead I decided to do a 5% band. Ie. If my portfolio drifts more then 5% from my target of 25% bonds I will rebalance. I guess you could also argue the calendar plays here a bit as I don’t usually check my allocation but every few months. But it would allow me to adjust if we hit another massive decline that I become aware of through other means. I obviously wrote this down in my investment plan.
Why So Formal with My Rebalance Strategy
Now I know some people are thinking, but why so formal? You could always just rebalance on the fly during a massive decline. Well if there is one thing I believe in when it comes to investing, doing anything with your investments based on emotions leads to bad outcomes. Knowing what I will do in a given situation, and having that written down, mitigates as much as possible the possibility I could make a market move based on emotions. Because I technically have decided what I am going to do long before it happens. Emotions are always stronger when an event occurs.
Perfect Is the Enemy of the Good
Is this the perfect rebalance strategy? No. Is my asset allocation for everyone? Also no. But the reality is, it fits my risk tolerance and emotions. That’s really what you should look for in your own asset allocation and rebalance strategy. That and to stick with it.
The people that truly lost big last year are those that abandoned their plan and sold everything during last year’s crash. Even without a major Covid rebalance my investments are up massively. I can live with that.