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Photo Credit: “balance scale”, © 2011 winnifredxoxo, Flickr | CC-BY | via Wylio

Asset Allocation: Easy as Pie

Rebalancing starts with ‘RE’ which means going back. If you intend to REbalance your portfolio, then at some point in the past your portfolio had to be balanced. But what does it mean to have a balanced portfolio?

A balanced portfolio reflects a thoughtful, and situationally relevant asset allocation strategy. Taking this quiz can help you find the balance that your portfolio needs. After that, your goal is simply to keep your pie chart looking like your target asset allocation.

Ideal asset allocation relative to actual asset allocation

Ideal asset allocation relative to actual asset allocation

My asset allocation strategy is on the left, but my actual asset allocation is on the right. Clearly, my portfolio is out of balance. To balance the portfolio, I’ll need to enact the changes below:

Change

Changes to portfolio in terms of % of total portfolio

Once you develop an asset allocation strategy, you will rebalance your portfolio as often as your actual allocation falls too far out of line with your target allocation.

Why should I rebalance my portfolio?

Over time, rebalancing your portfolio tends to yield higher performance than simply buying at a set asset allocation. Regular rebalancing forces you to use logic (buy low, sell high), rather than emotion to build your portfolio.

In a volatile market, most investors find it difficult to sell their strongest investments and buy the weakest performers, but rebalancing yields stronger performances. Take this example from 2008-2009, when the S&P 500 fell -37% over the course of a single year, and rebounded 26% the following year.

At the start of 2008, two investors invest $10K in an 80/20 mix of stocks and bonds. By the end of the year, both portfolios fell to a value of $7144.80

Jan 1,  2008 Performance Dec 31, 2008
S&P 500 $8,000 -37% $         5,040.00
Barclay’s Agg Bond $2,000 5.24% $         2,104.80
Total $10,000 $         7,144.80

One investor doesn’t touch his investments, and ends 2009 with a two year annualized return of -7.25%

Without Rebalancing Jan 1 2009 Performance Dec 31  2009 2 Year Annualized Return
S&P 500 $              5,040.00 26.46% $        6,373.58
Barclay’s Agg Bond $              2,104.80 5.93% $        2,229.61
$              7,144.80 $        8,603.20 -7.25%

The other investor rebalances his portfolio at the start of the 2009. He moves $675 from bonds to stocks to return to his original asset allocation (80% stocks and 20% bonds). After this move, his portfolio ends with a  two year annualized return of -6.5%. 

Rebalanced Portfolio Jan 1 2009 Performance Dec 31  2009 2 Year Annualized Return
S&P 500 $              5,715.84 26.46% $     7,228.25
Barclay’s Agg Bond $              1,428.96 5.93% $         1,513.70
$              7,144.80 $         8,741.95 -6.50%

Moving less than $700 from bonds to stocks caused the rebalanced portfolio to outperform the unbalanced portfolio by 75 basis points in the same market conditions.

Are you following through with your intentions?

Superior asset allocation drives superior long run performance, but asset allocation requires more than just a plan. Proper asset allocation requires timely information to make sound decisions, and regular maintenance (rebalancing) even in volatile markets.

When you set an asset allocation goal in DIY.Fund, we help you follow through on your intent. In addition to helping you understand your portfolio, we notify you when your portfolio is out of line with your goals. We provide you with customized portfolio information, so you can make the best decision at the right time.