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How we rebalance the Slow and Steady portfolio

Our Slow and Steady model portfolio was especially designed to minimise costs and hassle for small, passive investors right down to its rebalancing strategy. But how exactly does that strategy guide our new purchases?

The Slow and Steady rebalancing strategy

The Slow and Steady portfolio is rebalanced as a matter of course on a quarterly basis with cash from new contributions.

So every three months, fund purchases are automatically calibrated to return the portfolio to its target asset allocation:

  • UK equity: 20%
  • Developed World ex UK equity: 50%
  • Emerging market equity: 10%
  • UK gilts: 20%

N.B. Developed World ex UK equity is split between four funds (due to the lack of a single, no-trading fee fund in the UK) as follows:

  • North American equity: 27.5%
  • European equity ex UK: 12.5%
  • Japanese equity: 5%
  • Pacific equity ex Japan: 5%
  • Total: 50%

Rebalancing is the act of pruning back your risk. Without it the portfolio could mutate into a much hairier beast if, for example, the emerging markets fund went on the rampage. Over years, the portfolio could end up with a much higher percentage of its value bound up in this risky asset class than the envisaged 10%, if we did stood idly by.

So when it’s time for the portfolio’s quarterly £750 new contributions, we buy more of the under-performing funds and less of the out-performers, and take advantage of mean reversion.

Rebalancing slo-mo replay

The first time the Slow and Steady portfolio was rebalanced its market value was £3,017.84

It’s important that the rebalance takes into account the new cash added, so:

£3,017.84 + £750 = £3,767.84 (total portfolio value after drip-feed)

How much of this total should then be allocated to each asset class?

A quick example should do the trick. The target allocation for UK equity = 20% of £3,767.84.

£3767.84 / 100 = 37.6784
37.6784 x 20 = 753.568

So we want £753.57 of UK equity in the portfolio once the new cash is added.

The value of UK equity in the portfolio prior to the new cash = £607.10

£753.57 – £607.10 = £146.47

£146.47 is the amount of UK equity we should buy to ensure the asset is rebalanced to its target allocation of 20%.

That calculation is repeated for each fund in the portfolio to determine how much of each asset class we need to buy.

Eventually the portfolio will grow too big to be entirely rebalanced by new cash. At that point we’ll need to sell assets that exceed their target allocation and use the proceeds to pump up assets that fall short.

That won’t cause the Slow and Steady portfolio any trading cost pain though (the bane of rebalancing) because we’re cannily invested in index funds that don’t trigger broker fees.

Take it steady,
The Accumulator

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{ 8 comments… add one }
  • 1 PUJ April 12, 2011, 11:16 am

    What would you consider to be the best rebalancing time frame for a similar portfolio if there are no trading fees and no other tax implications?

    I assume you chose quarterly for the above as it allows you to come back to the subject regularly.

  • 2 Paul Claireaux April 12, 2011, 12:10 pm

    Hi,
    I’m just lovving those blackboard pictures.
    Please advise what software app you’re using for that.
    Regards

    Paul

  • 3 Jpax April 12, 2011, 1:42 pm

    I have 3 burning questions…

    Doesn’t each transaction incur a trading fee?

    If you rebalance quarterly, doesn’t the trading fees eat away at your overall return?

    How do you ‘automatically’ allocated your deposits? Is there a fund supermarket that you can set up rules to maintain a defined allocation?

  • 4 Open source portfolio April 12, 2011, 10:16 pm

    Interesting approach to rebalancing!

  • 5 John Pilkington April 12, 2011, 10:27 pm

    Well done for going through the details of the ‘maths’. as a non-maths person who loves learning about shares, bonds etc, this is so useful. Keep on Accumulating!

  • 6 The Accumulator April 15, 2011, 10:38 am

    @ PUJ – the research I have read convinces me there is no optimal rebalancing period that can guarantee better returns. The only criteria that matters to me is intervening often enough to keep my portfolio’s risk profile under control. I’ve chosen quarterly for the Slow & Steady portfolio because, as rebalancing costs absolutely nothing, it makes logical sense to reset to the target allocations every time new money goes in. My personal portfolio does incur costs when I rebalance, so I rebalance annually. That’s often enough to keep things on track given my risk tolerance and the fact that I don’t want to be fiddling with it all the time.

    @ Paul – Get your chalkboard here: http://www.simplediagrams.com/

    @ Jpax – No, those funds don’t incur trading costs at most online brokers. There may be a broker/supermarket that automatically allocates but I haven’t seen or heard of it. I just do the maths (or use a spreadsheet) and order accordingly. Doesn’t take long. Takes even less long if you do it annually.

    http://www.simplediagrams.com/

  • 7 emanon August 9, 2013, 12:50 pm

    If you do it annually into a portfolio that you drip feed on a monthly basis in order to maintain a healthy level of Averaging at the end of the year what would you do; sell off what is over the allocation limit and put into the lower assets with a drop in allocation or is there a better way to do this without any costs? i.e paying in less into the asset that is over its allocation and a little more into that which fell below it allocation?

  • 8 The Accumulator August 10, 2013, 8:47 pm

    @ emanon – that would certainly work as long as you weren’t dragging out the rebalancing over too long a period. An alternative is to use threshold rebalancing so an asset would be considered rebalanced if it’s in a range of say 18 – 22% of your portfolio: http://monevator.com/threshold-rebalancing/
    If you’re with a broker who doesn’t charge dealing costs for funds then of course you can rebalance without incurring costs at all.

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