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Practically Speaking, How Does One Rebalance?

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  • Practically Speaking, How Does One Rebalance?

    Hi all:

    My wife and I are both MDs and starting our attending jobs (hooray!) I've recently written out our investment policy statement, and felt pretty good about myself until I got down to the nitty gritty of writing an excel script to allocate monthly deferred benefits plus excess savings (again, hooray that we're going to more than hit our 401k/IRA limit) in a taxable account.

    Here's the situation, my wife and I intend to keep a joint "Portfolio", but we must (by necessity, I believe) have separate 401k/IRAs. Our warehouses, at a minimum include:

    1) My 401k (plus employer matching)
    2) Her 401k (no matching)
    3) My IRA
    4) Her IRA
    5) Our Taxable account

    For simplicity sake, let's say we only want to invest in (A) Total Stock Market (80% of Portfolio) and (B) Total Bond Market (20% of Portfolio). On a monthly basis, I will contribute to (1) until I hit my annualized maximum, then (2) until max, then (3) until max, etc... staying within the 80-20 allocation. Let's say (A) gains 10% while (B) gains 2%, and I need to rebalance after a year.

    How do I go about doing this since I cannot transfer assets between individual accounts? Would I have to just keep (A) AND (B) in each of (1-5) so the losses/gains are identical by proportion in each warehouse? Gets very complicated if I wanted to have a few more asset classes, no?

    Maybe I'm missing something, happy to learn and get help!


    Thanks,

    planck's constant

  • #2
    I would view it more as taxable account vs retirement space. You can rebalance within the retirement accounts without causing taxable events and as such there should not be any hesitation within the retirement accounts. Use new money as much as possible to keep your desired allocation. As last resort rebalance in the taxable account to make the whole portfolio what you want.

    Comment


    • #3
      I honestly have this question too. We haven’t reached that point yet, but someday we won’t be able to use new money to rebalance because the swings will be too big.

      And it seems like just selling and rebalancing with tax protected accounts isn’t a great idea in the long run because the tax protected accounts will be very unbalanced.

      Do people just eat the capital gains eventually to rebalance over all accounts? And hope that there are some paper losses some years to tax loss harvest?

      Is the above all just theoretical and it all works out in the end?

      Comment


      • #4
        Ideally one rebalances by increasing contributions to the under-weighted assets during the accumulation phase and by taking more in distributions from the over-weighted asset class during retirement. Hopefully you don't need to incur additional taxes and other transaction costs, just put new money where you need more of something or draw from where you have more than you desire as a percent of total asset allocation.

        Comment


        • #5
          Dicast : Great advice to look at tax-deferred vs taxable. Definitely not concerned about selling/buying within the former. You bring up another complication w/r/t capital gains from selling a likely higher-yield but tax-efficient asset (e.g. S&P 500 index) to buy more of a likely lower-growth but dividend bearing asset (e.g. AAA Corporates). Does anyone else see a direct conflict - at least from data in the past 60yrs - between tax-efficient portfolio allocation and rebalancing?

          I still have concern that ObgynMD points out, over time these individual deferred accounts will become imbalanced (w/r/t a prespecified asset allocation) and if we are keeping one portfolio jointly, I'm unsure how to rebalance the whole thing since (I think) it's not possible to treat my 401k, my IRA, her 401k, and her IRA as one big account. You can't just sell assets from one to buy more in another, right?

          As always appreciate brighter minds and deeper insights.

          Thanks,
          -E/f

          Comment


          • #6
            Originally posted by Hank View Post
            Ideally one rebalances by increasing contributions to the under-weighted assets during the accumulation phase and by taking more in distributions from the over-weighted asset class during retirement. Hopefully you don't need to incur additional taxes and other transaction costs, just put new money where you need more of something or draw from where you have more than you desire as a percent of total asset allocation.
            But what if one has a large taxable account, say high seven or eight digits (not us, but I image likely WCI/WBD/I bet several others here). Eventually if your taxable account is so high where you must incur capital gains (maybe even significant capital gains) to rebalance, what do people do? Is this the reason that people should consider real estate- to have paper losses? Is this why WCI has banked $500,000 from tax loss harvesting?

            Is there a way a simpleton without a real estate empire or their own business can plan for such first world problems?

            Comment


            • #7
              Originally posted by Hank View Post
              Ideally one rebalances by increasing contributions to the under-weighted assets during the accumulation phase and by taking more in distributions from the over-weighted asset class during retirement. Hopefully you don't need to incur additional taxes and other transaction costs, just put new money where you need more of something or draw from where you have more than you desire as a percent of total asset allocation.
              This is a great tip. However, can you do this in a manner where you don't have to change contribution structure every month? I'm looking for a "set it and forget it" except for yearly rebalancing. I guess I can just see where my portfolio is and change contributions at a quarterly or semi-annual basis?

              Thanks,
              -E/f

              Comment


              • #8
                Look at where you want to be, where you are, then adjust to get back where you want to be. Assuming you are putting a lot in every year (especially relative to your taxable brokerage balance), you could change your contributions / withdrawals pretty aggressively as infrequently as once a year. Expect things to revert to the mean as various asset classes outperform for a while then underperform throughout an economic cycle. (No, you probably can't predict when or to what magnitude, but expect things to revert to the mean over the longer term.)

                You also can rebalance in qualified / retirement accounts without a tax hit, but you still might incur transaction costs. You also get into asset allocation vs. asset location issues, but these are top 5% of first world problems.

                Comment


                • #9
                  This article has good visuals on asset location: Tax-efficient fund placement - Bogleheads

                  Comment


                  • #10
                    I have all the cap gains and dividends go to a sweep account and use this to rebalance along with new funds. This way you can allocate your lots and not get caught up in wash rules if you tax loss harvest. This is definitely not a set it and forget it method, but it also does not take that much work either. A few clicks once a month or two.

                    I would rather have a portfolio which is a little off, from a balancing perspective than pay additional taxes unnecessarily. You can always make this up with new deposits in the future, but once you give it to the government , you never get it back.

                    Comment


                    • #11
                      1. Originally posted by plancksconstant View Post
                        Dicast : Great advice to look at tax-deferred vs taxable. Definitely not concerned about selling/buying within the former. You bring up another complication w/r/t capital gains from selling a likely higher-yield but tax-efficient asset (e.g. S&P 500 index) to buy more of a likely lower-growth but dividend bearing asset (e.g. AAA Corporates). Does anyone else see a direct conflict - at least from data in the past 60yrs - between tax-efficient portfolio allocation and rebalancing?
                      Originally posted by plancksconstant View Post
                      I still have concern that ObgynMD points out, over time these individual deferred accounts will become imbalanced (w/r/t a prespecified asset allocation) and if we are keeping one portfolio jointly, I'm unsure how to rebalance the whole thing since (I think) it's not possible to treat my 401k, my IRA, her 401k, and her IRA as one big account. You can't just sell assets from one to buy more in another, right?

                      As always appreciate brighter minds and deeper insights.

                      Thanks,
                      -E/f
                      One point: Each account doesn’t hold the same AA. Your total desired AA is spread between all accounts. Taxable vs non-taxable is where you keep the investment to achieve the desired AA.
                      Typically bonds in tax protected.
                      1) Use new money to adjust to the desired AA
                      2) Periodically rebalance in the non-Taxable as needed (no tax).
                      3) Keep your equities in taxable in different equity investments so you don’t screw up TLH in the taxable.

                      You don’t give a flip whether each account gains or loses relative to the other. Total AA is what you rebalance.

                      https://www.whitecoatinvestor.com/re...ack-to-basics/

                      With multiple asset classes in your AA, simplest way is to adjust AA in one non-taxable account and leave the others on auto pilot. Don’t try to AA each account, keep them as simple as possible.

                      I don’t agree with trying to balance an individual account. Keep your AAA corporate bonds in one tax protected account (not some in each).
                      Yes each account will have different returns, so what?

                      Comment


                      • #12
                        One option would be to choose a mutual fund or ETF with a fixed stock: bond ratio that you like (such as Vanguard Wellington, with 65% stock:35% bonds) and use it for 100% of your taxable investments. Then you have no need to do any rebalancing within the taxable account, where you might incur capital gains. You could then periodically rebalance within your retirement accounts to keep the overall portfolio's stock: bond ratio at what you'd like it to be, since buying and selling assets within a retirement account triggers no capital gains.

                        Comment


                        • #13
                          You don't have to rebalance annually. I believe in Bernstein's 4 pillars, he says every few years (so 4 or 5). Arguably, one really needs to hold something for 10-20 years to know it's performance (if your weighted to international, small cap, etc). At this early stage, I think it's more prudent to get your desired AA down and make excess contributions to keep things balanced in a way you prefer, rather than worrying about rebalancing 7/1 of every year (or whatever date you have in your IPS).

                          Comment


                          • #14
                            What happens when you reach close to retirement age and you want to significantly increase your bond allocation? Do you turn your tax-deferred accounts entirely into bonds? And/or realize capital gains in order to move money in taxable accounts from stocks to bonds?

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                            • #15
                              since I cannot transfer assets between individual accounts?
                              That's my long-term point about the folly of treating all assets as one account. My view is each account should have it's own AA - with focus on intended date of liquidation, risk, and tax efficiency.

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