Question on Rebalancing and New Money

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
67vwbug
Posts: 49
Joined: Thu Apr 01, 2010 1:32 pm

Question on Rebalancing and New Money

Post by 67vwbug »

Hi all!

A comment by Larry in this thread brought up a point that was confusing to me.
larryswedroe wrote:But always rebalance with new cash
Say I deposit a portion of my check every payday (every 2 weeks) into a Roth IRA. Does that mean the new cash needs to be going into a fund (such as VMMXX) and holding there until my rebalance band is triggered?

Or should I be checking my AA every payday and depositing that money into the underperforming asset class, then rebalancing by band triggers if something major happens (by selling bonds to buy stocks in a stock drop, for instance)?

:?
User avatar
madsinger
Posts: 985
Joined: Sat Sep 29, 2007 3:26 pm

Re: Question on Rebalancing and New Money

Post by madsinger »

Hello 67vwbug,

My understanding of this advice "always rebalance with new cash", is that you should direct any new contributions to your investment portfolio into the asset class in your AA plan that is the most "below" its target value. This helps you avoid having to sell a higher performing asset and thus paying taxes on capital gains.

Your post seems to indicate that your bi-weekly contributions are going into a Roth IRA. If you are able to rebalance your portfolio by buying and selling within a tax deferred (or tax free) location, than there is no "tax penalty" for rebalancing.

Personally, I don't worry about which asset class my 401-k contributions go into. If they get out of whack, I can rebalance any time with no tax consequences.

-Brad.
User avatar
FelixTheCat
Posts: 2035
Joined: Sat Sep 24, 2011 12:39 am

Re: Question on Rebalancing and New Money

Post by FelixTheCat »

I'm sure others will correct me if I am incorrect. I believe the new cash rebalancing only applies to taxable accounts.

For example, Let's say your Total Stock Market fund increases in value where it is now 10% over target. Therefore, your Total International Market fund is under-weighted. You want to apply new money to the Total International Fund. If you try to rebalance by taking money out of your Total Stock fund than this will trigger a taxable event.
Felix is a wonderful, wonderful cat.
Johm221122
Posts: 6393
Joined: Fri May 13, 2011 6:27 pm

Re: Question on Rebalancing and New Money

Post by Johm221122 »

Yes,put new money in fund that is below your AA.Most important thing is in beginning is amount invested.A few % off your AA in beginning,will not make much difference
Topic Author
67vwbug
Posts: 49
Joined: Thu Apr 01, 2010 1:32 pm

Re: Question on Rebalancing and New Money

Post by 67vwbug »

Awesome. Thanks, all! That confirms what I was thinking.
the_one_smiley
Posts: 20
Joined: Fri Jan 01, 2010 3:23 pm

Re: Question on Rebalancing and New Money

Post by the_one_smiley »

In some cases, if you put an entire paycheck into the asset that is farthest below its allocation, it will overshoot and exceed its target allocation. Use my rebalancing calculator to contribute optimally and avoid this:
http://optimalrebalancing.tk
(note: Internet Explorer fails at rendering this site)

Rebalancing using new money is the way to go. If you contribute regularly and optimally, your portfolio will always converge towards its target allocation, reducing the chance that you'll exceed a rebalancing band.
User avatar
Kevin M
Posts: 15787
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

Re: Question on Rebalancing and New Money

Post by Kevin M »

Adding to the asset class(es) most below target makes sense for someone who is willing to pay enough attention to their portfolio to do it. In my experience, most people are not, and are probably best served with a Target Retirement or LifeStrategy fund if available.

I have two adult daughters who put all 401k and IRA contributions into money market funds. They use a spreadsheet to periodically move the cash into the funds in a way that moves their portfolio closer to target values. One of them does it weekly, the other monthly. I don't personally know anyone else who is willing to do anything like this.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
User avatar
Aptenodytes
Posts: 3786
Joined: Tue Feb 08, 2011 7:39 pm

Re: Question on Rebalancing and New Money

Post by Aptenodytes »

What you should do is adjust the assignment of new contributions on some regular basis. How frequently you do so is up to you. For some people, doing this every paycheck is fun -- a harmless way to be "active" with their portfolio. For others, that would be a dreary burden, so two or three times a year makes more sense. If two or three times a year is too much then Larry's advice isn't for you.

With new contributions the "bands" are not really relevant. You want to nudge the portfolio in the right direction, regardless of the bands.

You can think of the new contributions as a kind of tugboat nudging a bigger ship onto the right path. The power of the tugboat depends on the ratio of new contributions to your total portfolio. Once you get to the point where the new contributions are too small relative to your portfolio, it probably doesn't make sense to spend much time worrying about this. Right now I'm at about three quarters of a percent new money each month, and that's enough for me to justify the 5 minutes it takes to tweak the new allocations.

There's no point getting overly precise with this stuff, because the impact of this month's contribution is going to be muted by the impact of next month's market change. I usually just eyeball the assets, see which are below targets, and then assign new contributions in big round numbers in a way that moves in the right general direction.
Tower 18
Posts: 3
Joined: Thu Oct 27, 2011 8:53 pm

Re: Question on Rebalancing and New Money

Post by Tower 18 »

the_one_smiley wrote:In some cases, if you put an entire paycheck into the asset that is farthest below its allocation, it will overshoot and exceed its target allocation. Use my rebalancing calculator to contribute optimally and avoid this:
http://optimalrebalancing.tk
Thank you for putting this tool out for the community. I started using this calculator recently and have found it to be very helpful when I make contributions with new money every month. If you use some sort of glide path in your asset allocation (I use "age in bonds") and you know a bit of JavaScript, you can even automatically prepopulate the text area with your own target percentages.
User avatar
robolove
Posts: 121
Joined: Sat May 31, 2008 2:23 pm
Location: Tokyo

Re: Question on Rebalancing and New Money

Post by robolove »

Yes, Thank you for that calculator!
the_one_smiley
Posts: 20
Joined: Fri Jan 01, 2010 3:23 pm

Re: Question on Rebalancing and New Money

Post by the_one_smiley »

You're welcome! I'm happy to hear people are finding it useful. Prepopulating the textarea with JavaScript is a great idea; I like how it achieves personalization without a single bit of private information getting sent to anyone.
sketchy9
Posts: 205
Joined: Mon Oct 25, 2010 2:10 pm

Re: Question on Rebalancing and New Money

Post by sketchy9 »

the_one_smiley wrote:In some cases, if you put an entire paycheck into the asset that is farthest below its allocation, it will overshoot and exceed its target allocation. Use my rebalancing calculator to contribute optimally and avoid this:
http://optimalrebalancing.tk
(note: Internet Explorer fails at rendering this site)

Rebalancing using new money is the way to go. If you contribute regularly and optimally, your portfolio will always converge towards its target allocation, reducing the chance that you'll exceed a rebalancing band.
FYI IE 10 on Windows 8 consumer preview has no problem with your site. Thanks a bunch, that's a fantastic resource!

-R
Post Reply