Rebalance with new contributions to save on grief and cost

Investors with relatively small portfolios should always rebalance ^[2] with new contributions where possible to avoid having their wealth whittled away by trading costs.

Most rebalancing advice suggests:

1. Sell out-performing assets.
2. Sink the proceeds into under-performers.

But this can mean paying a double-dose of broker’s dealing fees ^[10]: once to sell and once to buy for every pair of assets you need to rebalance.

And while you can buy for £1.50 per trade using regular purchase schemes, you’ll pay at least £5 to £10 to sell, if you’re dealing in ETFs, shares, investment trusts, or funds where your platform charges trading fees. (See our broker comparison table ^[11] for the cheapest options).

Rebalancing with new contributions cuts out the selling costs at a stroke.

Using this technique, the lion’s share of new contributions are funneled directly into under-performers to bring them into line with your desired asset allocation ^[12].

^[13]

How to rebalance with new contributions

New contributions can be any combination of:

• New cash
• Dividend income
• Interest income

Whenever you inject new money, calculate the following:

1. Add up the total worth of your portfolio before any purchases.
2. Add that figure to the cash value of your new contribution. This gives you the portfolio’s new total value after your imminent purchases.
3. Recall your target asset allocation percentages.
4. Calculate the cash value of each asset at its target percentage of your portfolio’s new total.
5. The difference between the current value of the asset and its new value = the amount of new contribution to put into that particular asset.

A very simple example

Current worth of the KISS portfolio = £10,000

New contribution = £5,000

New total value of portfolio = £15,000

Desired asset allocation (%) = 60% equity, 40% bonds

Desired asset allocation of £15K portfolio (£) = £9K equity, £6K bonds

Current asset allocation (£) = £7K equity, £3K bonds

Subtract current value from desired value = £2K equity, £3K bonds

So our £5K new contribution neatly rebalances the KISS portfolio back to a 60:40 equity/bond allocation if we buy £2K in equity and £3K in bonds.

If the new/desired value of the asset was a minus number then your existing allocation is so out of whack that even the new contribution can’t get you back on track. You need to sell an amount of the bloated asset equal to the minus number to rebalance.

Do all that using the power of your brain, or else use this excellent rebalancing spreadsheet ^[14] from Canadian Couch Potato.

Never perfectly rebalanced

Of course, you don’t have to rebalance every time you drip feed in new contributions.

I personally calendar rebalance ^[8] once a year. But because I contribute monthly – buying one or two funds a month – my ideal asset allocation is only ever a target I work towards with new cash.

I work out how much I think I’ll invest in the 12 months ahead, and use that amount plus my existing portfolio’s value on rebalancing day to calculate how much I should feed into each asset over the course of the year.

In reality my portfolio is unlikely ever to be rebalanced perfectly again, except by utter fluke.

Rebalancing to a range ^[9] gives you even greater leeway to adjust asset allocations for less cost.

You can rebalance your portfolio with abandon if you’re purely invested in funds that avoid dealer’s fees, such as the trackers used in Monevator’s Slow and Steady model portfolio ^[15]. However, the evidence suggests there’s normally no need to rebalance more than once a year and doing it with new contributions will certainly save you time and hassle.

Take it steady,
The Accumulator

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Use threshold rebalancing to lower your portfolio’s risk ^[9]