Practicability and statistical likelihood of better results.
Well that’s what I’ve been asking myself.
The intuitive answer is “to keep asset allocation at the predefined risk”, however it feels more like “to do some valuation based market timing”.
In the first case, one might argue for as-frequent-as-possible rebalancing.
In the second case, threshold based seems logical.
A time based one doesn’t really make sense for either, however, it seems to be the easiest, most practical way to do it.
Hm, I like that idea. Thanks.
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Rebalancing is market timing. It is a rules-based mechanical one that is meant to have us buy low and sell high, which is why you are piling cash when stocks rise, especially if rebalancing is only done with new inputs and your portfolio is already consequential.
If there’s an itch to scratch, one solution might be to change your rules and accept to sell to rebalance, which would mean rebalancing at once and allowing the following months to sometimes go into cash and sometimes go into stocks.
Rebalancing bands, as you suggest, might also change that though may not help that much if you invest your new inputs into the class that you are most under-invested in relative to your allocation.
Yet another solution might be to use some kind of invested asset for fixed income instead of cash. That could give you the feeling that you are investing the assets and that they are not just sitting iddle waiting for a stock crash (though the operative result would be the same).
Maybe the best solution, which you have already stated, would be to make peace with the situation and just keep as you are doing.
It is possible that you have reached a point where your new inputs have become (almost) inconsequential to your investing results. Maybe modelling outcomes with or without new inputs, with or without a prolonged downturn might cast some light on that possibility. If it is so, a question I would ask myself is if those new inputs are the best use of my time and if reducing my workload and % of occupation (if possible) wouldn’t be a more desirable situation for similar enough financial results (maybe better if the time freed is used productively and generates more income than the current occupation does).
But yes, what you are doing is market timing based on mechanical rules, putting nuts away for when a crash comes, with potentially the hopes that no crash does (that’s a good outcome for you) or maybe that one does (that may be a good outcome too if you are far enough away from reaching your #FU number).
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I might still not get the full picture. To me, rebalancing is the opposite of market timing. It’s sticking to your investment policy.
As a simple example: I wish to invest 80% in global world stocks based on their market cap and 20% in Swiss mid-size stocks. Global world stocks are covered by VT, Swiss mid-size stocks are represented by CHSMIM. My reference currency is CHF.
Because of market movements (sharp rise of tech stocks, currency fluctuations, …) there is a constant deviation from the 80/20 ratio. Once a year, my policy tells me to reset my investments to the 80/20 ratio. This means I buy and sell VT and CHSMIM so that the 80/20 ratio is reestablished.
All of this has nothing to do with market timing, it’s a mechanical act once a year.
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Your strategy is completely fine, you just need to follow it 
.
What I don’t understand:
I am executing a similar strategy, but for me, “rebalance with new contributions” and “rebalance once per year” sound contradictory. If you rebalance with new contributions, you do it when they are available - which is normally every month. Then you have some possibilities, that will scratch your itch to do something.
I assume you have stocks + cash, the latter being the only reasonable type of fixed income for CHF-based investors, from my point of view.
- When new money are available (once per month), you calculate your holdings and direct the new money to the asset that is underweighed.
That’s all.
Important, you don’t do anything with already existing holdings, neither selling stocks nor using already accumulated cash holdings to buy more stocks.
- Simple,
- active enough to satisfy your need to be active, but not enough to ruin your financial goals.
- Cautious, as you avoid rapid changes in the composition of your portfolio. The next dip might take longer to undip than 2-3 months we are used to now.
The problem:
- your portfolio can stay out of desired allocation for a very long time, especially after it grows significantly, or your savings diminish.
- New money are added to cash holdings. Then, every time (=once per month), you check your portfolio. If cash holdings are above the target, you rebalance with all the cash.
The difference to 1. is that you use already allocated cash to buy more stocks.
- Satisfies your activity bias even more than 1.
- Still simple and automatic enough to not ruin your portfolio.
- More aggressive in buying dips etc.
- When you rebalance, your portfolio is rebalanced.
Disadvantages:
- Will lead to rapid changes in the composition of your portfolio - by design. As a mitigation, you can define the maximum amount that you move from cash to stocks every time - for example 3% of the portfolio (see @TeaGhost).
If you have holdings distributing dividends, I would add them to the cash part and proceed accordingly, but don’t focus on this minutia.
Personally I prefer second approach.
And now an important take from me. In contrast to what @Wolverine writes, I have a strong opinion that individual investors should never diminish their stock holdings during the accumulation stage. Reshuffling holdings is fine, selling positions at an expensive broker to rebuy at a cheaper one is even better - but don’t decrease your stocks exposure. I can imagine an intermediate stage of 3-5 years between accumulation and consumption stages, where one can do true rebalancing in both directions, but before better not.
An objective reason for it is that you regularly get new cash, but you don’t receive shares of your favorite ETF. So, sooner or later your cash holdings will catch up with their target weight, especially if you add dividends to them.
Rebalancing from stocks to cash might sound good from a risk-adjusted performance perspective, but personal finance is 10% math and finance and 90% behavioral psychology. I think that making one iron rule I DON’T SELL will force you to navigate through all difficult periods. You should buy low, buy high, and never regret buying. In this aspect, “buy and hold” gets a new meaning - you buy and you hold your emotions about your financial actions.
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