I use my asset allocation as a tool to manage my current and future investments. I always aim to have a fixed percentage of my investments in each asset class. In my previous post, I presented my asset allocation and target percentages for each asset class.
As the value of various asset classes rise and fall, I will buy or sell to keep the portfolio balanced to the target percentages.
Let’s take a look at how this works with an example. If my large cap US funds depreciate to 9% of the entire portfolio (instead of the target 11%) while my developed international funds appreciate to 22% of the entire portfolio (instead of 20%), it is time to make some trades. I need to sell 2% (or $20,000 in a $1 million portfolio) of the developed international funds and use the proceeds to buy 2% of the large cap US funds.
I have found the easiest way to track my asset allocation is with the free investment management tools at Personal Capital (review here). I could use the built in Personal Capital asset allocation tool:
It works really well, and gives you an immediate overview of all the asset classes in your portfolio. Asset classes like US small cap value and emerging markets are reported separately within the US Stocks and International Stocks groupings. The US stocks breakdown in my portfolio looks like this:
Instead of using Personal Capital’s awesome built in asset allocation tools, I get a little nerdy. I developed my own spreadsheet. I simply copy all my investment holdings from Personal Capital and paste the holdings into my “portfolio analysis” spreadsheet.
Before Personal Capital, it was an arduous process to log in to multiple brokerage accounts, IRA’s, 401k’s, and health savings accounts for Mrs. RootofGood and myself. All the far flung accounts presented their data in different formats, and it was a rather time consuming chore to download, copy, and paste the data into my portfolio analysis spreadsheet. All those manual operations lend themselves to data entry errors as well. Not a pretty picture. I’m glad that Personal Capital consolidated all my accounts into one screen, because it makes this particular task (analyzing my asset allocation) incredibly easy and streamlined.
Here is how Personal Capital presents the holdings data:
I have asked Personal Capital for a download function to get a CSV or XLS file of holdings data, but they don’t have the functionality yet. In the meantime, I copy and paste the holdings data and it works for me (huge time saver).
After I dump the holdings data into my portfolio analysis spreadsheet, I can see my target asset allocation percentages and my current asset allocation percentages side by side. I created a column that shows me the exact amount I need to add or subtract from a given asset class.
The graphic shows today’s current asset allocation in my portfolio with a hypothetical $1,000,000 portfolio value. That gives us some nice round numbers to discuss.
Overall, things look pretty good (given I haven’t touched my investments for 3 months). I’m underweight on the US large cap allocation by 0.8% (10.2% currently versus 11.0% target) and overweight on the US large cap value allocation by 1.0% (12.0% currently versus 11.0% target). I need to sell some US large cap value funds and buy some US large cap funds. The US REITS are 0.4% underweight (5.6% currently versus 6.0% target). The other asset classes don’t deviate more than 0.2% from their respective targets, so I probably won’t do anything to them right now. Keep it lazy, folks.
What do I actually need to do to get all my holdings close to their target allocation percentages? I’ll take a little shortcut and head straight to one account and do all the trading there. Mrs. RootofGood’s awesome 401k has access to institutional share classes of Vanguard funds in the large cap, large cap value, and US REIT sectors.
I need to sell $10,000 of the Vanguard Value Index Fund – VIVIX (the large cap value fund) and then buy $7,000 of the Vanguard Total Stock Market Index Fund – VITSX (the large cap fund) and buy $3,000 of the Vanguard REIT Index Fund – VGSNX (the US REIT fund).
TIP: If you want to use these funds in your own asset allocation, find the equivalent funds in “Investor” or “Admiral” share classes. These ticker symbols are for the “institutional” share class through Mrs. RootofGood’s 401k. Unless you have a cool $5,000,000 per fund, you can’t get in as an individual investor. Investor and Admiral class shares have a $3,000 and $10,000 minimum initial purchase. In a future article I will provide you with mutual funds in each of the asset classes that I consider to be the best available.
One of my investment goals is to keep the portfolio management simple. That’s why I don’t feel compelled to get to my exact target asset allocation in every asset class. If each asset class is within a few tenths of a percent of the target, that’s good enough for me. Any more micromanagement and you’ll feel like you are picking fleas off a dog – a whole bunch of moving targets zigzagging all over and you’ll waste a lot of time chasing the little buggers without a lot to show for it at the end of the day.
That’s why I only bought $7,000 of the large cap and $3,000 of the US REIT. I should have bought $8,000 of the large cap and $4,000 of the US REIT according to my analysis spreadsheet. I chose not to bother with buying the exact amount since I would have to go to multiple accounts and complete additional transactions to reach the exact asset allocation targets. Being just a small bit off (around 0.1%) is okay.
What if I held all of my large cap value allocation in my taxable account and I was sitting on $60,000 of capital gains? Selling $10,000 of the large cap value fund would result in $5,000 of capital gains that might cost me a lot at tax time. As a result, I want to avoid selling highly appreciated shares.
There is a different way I could get back to a balanced portfolio without selling anything. I can simply direct new investments into the underweight asset classes. In our case, Mrs. RootofGood is still working, and contributes around $2,000 per month into her 401k (employer match plus employee contribution). She can direct her monthly 401k contributions into the funds that are most underweighted. Since the large cap asset class is $8,000 below the target value and the US REIT asset class is $4,000 below the target value, she can direct 67% of monthly contributions to the large cap fund and 33% to the US REIT fund. After six months, she will have contributed $8,000 to the large cap fund and $4,000 to the US REIT fund.
In this latter example, you may have noticed I didn’t do anything to reduce the large cap value’s overweighting of $10,000. Time for a diet! I’m going to starve the asset class by not feeding it more contributions. With new contributions going elsewhere, the values in the other asset classes in the portfolio will rise, and the large cap value balance will remain about the same (barring big moves in the market). By directing new investment purchases into the most underweight asset classes, it is possible to slowly bring the portfolio into balance. It’s like steering a large ocean liner – you make small corrections on the rudder to keep on course.
And that’s how I balance my investment portfolio. As you can see, after three months of ignoring my portfolio, it is still mostly balanced with just a few asset classes out of whack. I don’t spend a lot of time managing my investments to a tight asset allocation target. I don’t think it increases investment returns to rebalance too often. I think it’s pretty cool that the portfolio produces enough returns to fund our living in perpetuity, and I don’t have to spend hardly any time micromanaging the investments.
Emotion and market timing can be the investor’s biggest enemies. Using a target asset allocation takes the emotion and thinking out of investing. I recognize I’m no smarter than the thousands of computers and active traders at investment banks and hedge funds. My investing goal is to keep my trading costs and investment management expenses to a minimum, and allow the investments to grow long term.
Figuring out what method of rebalancing works best for you might take a little time. There are free tools out there like Personal Capital to pull investment data from your IRA’s, 401k’s, and brokerage accounts and consolidate it in one place. Personal Capital’s built in asset allocation overview might be enough for you to manage your asset allocation and rebalance your portfolio.
In this post on my portfolio’s dividends, I included a chart that shows specific mutual funds and exchange traded funds (ETF’s) I hold in each of the asset classes in my asset allocation.
Do you have a similar (or better!) method of managing a passive index fund portfolio like mine? What are your rebalancing rules or triggers?
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