A reader writes in, asking:
“Some people rebalance once a year, others rebalance either more times a year, or when a particular fund goes up or down more than a certain percentage. When, if ever, does rebalancing become a form of market timing, or is all rebalancing, regardless of when it is done, a different name for market timing?”
Personally, I dislike the term “market timing.” It includes so many different things that I don’t think it’s very helpful as a descriptor. For example, market timing could include:
- Day trading back and forth between cash and a total market ETF (which is clearly unwise for most people), or
- A one-time decision to move a portion of one’s portfolio to an inflation-adjusted lifetime annuity because recent returns have been good and interest rates are high (which, depending on circumstances, could be a perfectly wise decision).
In other words, I don’t think it’s particularly useful to ask whether rebalancing is a form of market timing. I think it’s more useful to get right to the point and ask if you should rebalance your portfolio and, if so, when you should do so.
What Would Happen if You Never Rebalanced?
In my view, the primary goal of rebalancing is to keep the risk level of your portfolio approximately where you want it to be. If you never rebalanced, it’s likely that stocks would eventually dominate your portfolio because of their higher long-term returns, thereby causing your portfolio to get riskier and riskier as you age. For most people, that would not be a good thing.
And if you’re going to be rebalancing, you obviously have to settle on some plan as far as when to do it. And you have to choose between the various options somehow.
When to Rebalance
One way to choose between rebalancing methods would be to select based on ease of implementation. That might lead you to rebalance, for example, every year on your birthday (woohoo! rebalancing party!) or to use an “all-in-one” fund that rebalances for you automatically.
Or, you could go about the risk-control directly, checking your portfolio on a regular basis and rebalancing any time your asset allocation is out of whack by more than a certain amount. For example, in his Only Guide You’ll Ever Need for the Right Financial Plan, Larry Swedroe suggests rebalancing when a holding is off by an amount equal to 5% of your portfolio balance or 25% of the holding’s intended balance.
Alternatively, you could choose based on some rationale for why a given method might earn slightly better returns than another method. For example, you might note that stocks have historically shown momentum over periods of less than one year, so you choose to rebalance every two years rather than rebalancing more frequently.
I think any of the above rebalancing strategies would be perfectly reasonable — even if they could be referred to as market timing. Most important, in my opinion, is to pick a method and stick with it so that you know your asset allocation (and therefore, the risk level of your portfolio) will not get too far out of whack.