I would like to start a discussion on re-balancing. It seems that re-balancing involves two parts, re-balancing between your stock/bond allocation (for example 60/40 split), and re-balancing your stock allocation (large cap vs. small cap vs. international, etc). The main reason for re-balancing is to reduce risk (so you don’t run out of money before you do) or increase your investment return (so your withdraw rate can be a little bigger), which are often at odds with one another. Let’s start with stock/bond allocation. What you mostly see on the internet and from investment firms is you are supposed to re-balance ever year, even quarterly. Where did that come from? It’s not really based on anything. My guess it’s from investment firms that will make money on clients re-balancing and paying for the transactions. Looking at work published by Campbell Harvey 2014 (Click on open PDR in browser: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2488552 ) and Michael H. McClung 2015, re-balancing less often is better in terms of increasing your total returns. If safety is your main concern, then re-balance more often as explained by Kitces: https://www.kitces.com/blog/how-rebalancing-usually-reduces-long-term-returns-but-is-good-risk-management-anyway/
If you had an asset allocation that was 50% stock/50% bond at the outset of the most recent market rally--which stretches back to March 9, 2009, and did not re-balance, your asset allocation by this summer would be about 75% stocks/25% bonds. By any reasonable standard, you should have re-balanced a long time ago to cut down your portfolio's equity weighting in an effort to reduce risk in your portfolio before the market does it for you. However, right now you would be rich!
I like what McClung has come up with. Start with whatever stock/bond allocations you want (within reason) say 60/40. You would take money out of your bond allocation to live on. The only time you would re-balance is when your stock valuation increased by 20%. You would then sell the increase and buy more bonds. The stocks you would sell would be used to return your stock allocation (large cap vs. small cap vs. international, etc.) to their starting position. This way you would never have to buy stocks ever again and never have to worry about selling low in a down market. With a 60/40 allocation and a 4% withdraw rate, your money will not run out (30 year retirement) based on historical (backtesting) simulations.
Good point to bring up!
You can eliminate one type of rebalancing you mention by simply holding a total US stock market ETF like VTI. Poof, done. No more worrying about your spread between large-caps, small-caps, value, growth, tech, etc. You own it all. It works and is what's recommended by folks like Warren Buffet and Vanguard. Take all the guesswork and stress out of that part. I compliment that with a total international ETF in the equity portion of my clients' asset allocation. Simple, *very* low cost, easy to understand and manage - very important for my clients. They can fire me when they're comfortable and want to drive, as I teach them how to do it.
On the second rebalancing - to keep your asset allocation (AA) where you're comfortable, be careful. Rebalancing in brokerage accounts has tax considerations. You're realizing those capital gains so make sure you know what you're doing. In traditional retirement accounts (IRA, 401k/403b/457, etc) you can rebalance all you like. But again, don't get too neurotic. One guideline i use for clients is to rebalance for them if the AA strays 5% from their target. Usually once a year, unless I see some big market event, then I jump in and get them fixed up, if circumstances determine it's prudent (tax and other factors considered). Roboadvisors will do this for you, if you trust the algorithms (didn't work out well for those 787 Max passengers...). You're right though, some brokers or advisors will rebalance often as it can be profitable for them (but bad for clients).
As well, make sure your asset allocation (equities/stocks to bonds/fixed income) is aligned with not only your income needs and time horizon, but *your* comfort zone, so you're not stressed during changing market conditions. I use a cool product called Riskalyze with my clients to measure this. It's really useful when (as is often the case) one person in a relationship is very risk averse, and the other isn't. We get them both to a place of comfort. It's a beautiful thing 🙂
Investment Advisor/Financial Counselor/Retirement Planner
Emancipare Investment Advisors LLC
Taxable accounts definitely need more care then retirement accounts. Fortunately, long term capital gains (LTCG) are based on Taxable income, not adjusted gross income (AGI). For couples filing jointly, the 0% LTCG tax rate goes from $0 to $80,800. As the name implies, LTGC are based on the gains your investment made. For example, if you sold your equities for $150,000, but it originally cost you $60,000 to buy, your taxable amount is $90,000. You then subtract your standard deduction (if you are not itemizing) of $25,100 and get $64,900 taxable income. You pay $0 in Federal taxes. State taxes is another matter. You could then withdraw $15,900 from an IRA, pay 10% Fed tax on that amount ($1,590) and still pay $0 Fed tax on your LTCG. If you have less LTCGs I would still withdraw from my IRA up to the top of the 12% tax bracket (as long as your taxable income remains below $80,800) Do it now because the 12% bracket goes up to 15% starting in 2026. If you put money into a Health Saving Account your taxable income (as well as AGI) goes down further. Of course this assumes you are not getting Social Security, pensions, etc., that would add a little complexity.