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Strategic Portfolio Rebalancing

Whenever I see the market dip, as it has in the past few days, my first instinct is to invest more money into it. With time I’ve grown balder but also wiser. I have learned that strategic portfolio rebalancing is smarter than giving up my cash liquidity.

Over the past month my Total Stock Index Fund (VTSAX) has dropped by 7%. I didn’t know whether it would keep going down or recover soon. But I knew that a 7% drop is a good time for me to invest more money.

In the past I would take my Emergency Fund cash or my buffer cash in my checking account and buy more of the depreciated fund. Now, I rebalance my portfolio and achieve the same results. Though the Godfather makes an argument that you don’t need an emergency fund when retired.

Portfolio Rebalancing

Let’s look at my private brokerage where I hold the following 4 index funds:

  • VMLTX (Bond)
  • VTSAX (Total US Stock)
  • VTIAX (Total International Stock)
  • VEMAX (Emerging Market Stock)

When the market shifts, as it has done in the past few weeks, bonds and stocks often move in opposite directions. My bond fund (VMLTX) went up as my stock funds went down.

Because I had an appreciation in my bond funds I was able to sell some of these and buy more of the depreciated stock funds. This is called rebalancing and is executed through an exchange trade.

Exchanging Funds

In this case I sold off $5,000 of my bond fund and bought:

  • $2,500 of my Total US Stock fund (VTSAX)
  • $1,250 of my Total International Stock (VTIAX)
  • $1,250 of my Total Emerging Market Stock (VEMAX)

This is what the screenshot looks like when you execute the exchange trade. It’s rather easy to do. And if you have a set asset allocation, which you should, it’s super easy to execute when your AA shifts.

Looking at my transaction history, I sold the bond fund at $11.03 per share. So I sold a total of 339 shares of it.

I then bought:

  • 36 shares of Emerging Markets at $33.99 per share
  • 46 shares of Total International at $27.27 per share
  • 36.5 shares of Total US at $68.36

Purpose of Rebalancing

So why rebalance? Well, the point is to sell the funds which are going up in order to buy those which are cheaper. That’s why it’s good to hold different asset classes because they tend to move in opposite directions.

For example, when there is investor panic, people tend to crowd into bond funds and sell out of their stock funds. This drive up the price of bonds and drives the price of stocks down – usually.

So now, stocks become a better deal and bonds are artificially inflated. So it’s good to sell those bond funds while they are up and buy the stock funds which are undervalued.

Different Asset Classes

You can do this for every kind of investment: REITs, bonds, stocks, mutual funds, ETF’s, commodities, CD’s, etc. The most important factor is that your investments have liquidity so that you can make this change.

Real estate is tough because you won’t be able to sell your real estate over a 24 hour period and dump the money into stocks. But RE has other added benefits. To each their poison.

Long-Term Investing

This is why I enjoy long-term investing. It’s less work and all I have to do is a little portfolio rebalancing from time to time. It beats having to sit by my computer every morning trading individual stocks.

And if you don’t like this part, you can use a service such as Betterment which will do the rebalancing for you. It’s even less work and you give up only a tiny expense ratio in return.

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