Tag Archives: Portfolio Rebalancing

The Benefits of a Balanced Portfolio

Balance is important in almost every area of life.  We should eat a balanced diet including food from every food group to ensure our bodies get proper nutrition.  We should balance the type of exercise we perform including strength training, cardio, and stretching.  Having a good work-life balance leads to improved productivity and happiness.  There should also be a balance in how we invest and that can be accomplished with a balanced portfolio.

To add balance as an investor means to invest in different asset classes that have an inverse relationship.  A balanced portfolio is an asset allocation that has balanced percentages of stocks and bonds.  It could be 50% invested in stocks and 50% invested in bonds.  Most balanced portfolios utilize an asset allocation of 60% in stocks and 40% in bonds.  However, the asset allocation might be outside of those bands.

The concept of the balanced portfolio was made popular by Harry Markowitz.  In 1952, Harry Markowitz wrote a paper in the Journal of Finance where he introduced his hypothesis on Modern Portfolio Theory (MPT).  The basic theory of Modern Portfolio Theory is that an investor can balance the expected return of a portfolio and risk by using diversification.

Modern Portfolio Theory suggests that an investor can construct an efficient frontier based portfolio by investing in more than one equity or fund.  Portfolios that are based on the efficient frontier are highly diversified.  The efficient frontier is a balance of diversifying across risky investments with a high potential for return with a low-risk investment that produces a lower return.  The optimal portfolio is designed to strike a balance between securities that produce the highest potential returns with securities that have a lower potential for return but balance out the risk.


Sample Balanced Portfolios

There are many ways to construct a balanced portfolio.  Below are two popular and simple balanced portfolios.  They are both based on a 60/40 asset allocation.  They incorporate a slightly different approach based on market capitalization.

Value Tilting

The Coffee House Portfolio was created by a Bill Schultheis.  Bill is a Seattle based financial advisor who created the Coffee House Portfolio for investors to build wealth, ignore Wall Street, and get on with their life.  The Coffee House Portfolio is considered a lazy portfolio.  Bill also published a book The Coffeehouse Investor that covers The Coffee House Portfolio in greater detail.  The Coffee House Portfolio uses a tilt towards small cap stocks as well as value stocks.  Small and value stocks have historically outperformed growth stocks.  Value stocks are undervalued based on fundamental analysis.  Please keep in mind, however, that there is no guarantee of this moving forward.  This asset allocation is well suited for investors who prefer a slice-and-dice approach to asset allocation.


Large Blend – 10%

Large Value – 10%

Small Cap Blend – 10%

Small Cap Value – 10%

REITS – 10%

Total International – 10%

Total Bond Market – 40%


1-Year Return = 10.94%

5-Year Return = 6.63%

10 Year Return = 5.97%

Market Capitalization Weighted

Another lazy portfolio is the three-fund portfolio.  While I am not sure if it was created by Taylor Larimore, it was made popular by him and the other Bogleheads in their book The Bogleheads’ Guide to Investing. The three-fund portfolio is made up of three mutual funds.  Even though it only invests in 3 mutual funds, it invests in 10,000 stocks.  This portfolio is highly tax-efficient because there is little turnover.  It contains every domestic and international large-cap, mid-cap and small-cap stock.  The three-fund portfolio is market cap weighted to prevent any front-running.  There is not any risk of underperforming the market like with value tilting because this is the market.  It is truly a simple portfolio to manage.  It can be allocated in many ways to suit an investors goals and risk tolerance.  Below is an example of how it can be used as a balanced 60/40 portfolio:


Total Stock Market – 40%

Total International Stock Market – 20%

Total Bond Market – 40%


1-Year Return = 7.05%

5-Year Return = 8.62

10-Year Return = 5.26

The Benefits

The best aspect of a balanced portfolio is that it allows the investor to control risk.  It is not risk-free like an FDIC backed certificate of deposit.  The risk is controlled by way of rebalancing.  A balanced portfolio is easy to manage and rebalance when it falls out of alignment due to market performance.

Let us assume that there is a market correction and a decrease in the price of stocks.  The portfolio that was once 60% in stocks and 40% in bonds is now out of alignment.  The asset allocation is currently 55% in stocks and 45% in bonds.  By rebalancing, the investor can sell bonds high and rebalance to the original asset allocation.

This systematic approach takes emotions out of the process and stands in the way of an investor making a poor decision.  This prevents investors from chasing performance.  It always forces the investor to buy low and sell high.

Just keep in mind that if this is done in a taxable account, it could trigger a tax consequence.  It is best to rebalance in a 401K or IRA because it has zero impact on taxes.  It is also wise to limit rebalancing to only once every year or no more than once every six months.

Unlimited Options

When it comes to investing, there is no such thing as having the perfect portfolio.  By using a balanced portfolio, an investor can avoid putting all of their eggs in one basket.  If an investor only invests in bonds their holdings will be secure, but the low returns might not keep up with the long-term rate of inflation.  On the other hand, if an investor only invests in equities, a major market crash could cut the value of their life savings in half.

A balanced portfolio is a diversified portfolio.  It reduces risk and can increase returns over the long term.  A balanced portfolio can be customized to meet the risk tolerance and investment goals for investors in every age group.  It can be created for both growth investors and for those who are seeking income.

A balanced portfolio can be constructed with many different funds or ETFs across various asset classes like the two above examples.  Individual securities can be used as well.  A balanced portfolio can also be made up of one mutual fund.

There are many options for investors who want to just use a single mutual fund.  There are options for investors who like to use low-cost index funds.  There are balanced funds for investors who prefer active management.

For investors who are near or in retirement, the Vanguard Wellesley Income Fund (VWINX) is a good option.  The Wellesley Income Fund (VWINX) is actively managed and is composed of 40% in stocks and 60% in bonds.  Even though it is an active fund, the Wellesley Income Fund (VWINX) has a low expense ratio of  0.22%.

Younger investors might want to own more stocks than bonds.  A more aggressive balanced fund for them to consider is the Vanguard LifeStrategy Growth Fund (VASGX).  The Vanguard LifeStrategy Growth Fund (VASGX) uses index funds for its allocation of 80% in stocks and 20% in bonds.


Just be aware that there is still a risk when investing in a balanced portfolio.  A balanced portfolio just helps to reduce risk.  It does not eliminate it.

An investor can design their own balanced portfolio.  There are also mutual funds that allow investors to own a balanced portfolio with one single fund.  There are options for investors of every age and risk tolerance profile.  A balanced portfolio is a good option for both new as well as experienced investors.

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Please consult with a financial professional before you ever make any investment decisions and read the Disclaimer page.

Stocks: Buy Low, Sell High

When it comes to investing, the one saying that most investors have heard countless times is to buy low and sell high.  In other words, buy stocks when they are selling at the bottom of the market and sell them when they become overpriced.  In theory, this is great advice.  In practice, it is very hard for professionals to do and almost impossible for individual investors to do.

Many investors try to base their approach to buying low and selling high to where the economy is in the business cycle.  When the economy is in a recession, stocks tend to be priced low.  As the economy improves, the indexes that track the prices of stocks go up in value.  They tend to continue to increase while the economy expands.  This continues to occur until the economy falls into another recession.  A recession is generally based on two consecutive periods of negative GDP growth.  This business cycle historically runs its course about every decade.

The stock market has been making steady gains since March of 2009.  Many people have grown wealthy as the result of those gains.  That period of recovery and expansion has been going on now for over 8 years.

Many economists, professional investors, and members of the financial media are calling for a market correction based on where we are in the business cycle.  Unfortunately, based on how the economy works, they are correct.  Odds are, it will happen.  The problem is that nobody knows for sure when it will happen.  It could occur tomorrow or it might not occur until many years from now.

How can an investor buy low and sell high? To do so, an investor must buy investments that are priced low in relation to what the business is truly worth.  Not only is this hard for individual investors to do on a quantitative level, it is hard to do on a psychological level.  This requires investors to buy when the media is screaming to sell their stocks, people are losing their jobs, businesses are filing Chapter-11, and there is little hope on the horizon.

The best approach an individual investor should take is to not make investment decisions based on the current state of the business cycle.  An investment plan should be created for all economic conditions.  An asset allocation should be selected based on age and risk tolerance.  When most investors try to buy low and sell high, they end up doing the opposite.

If it is that difficult to buy low and sell high, what should an investor do?  A good starting point is to not try to time the market.  Ignore the noise coming from the financial media.  If you want to read about investing, go to my Resources page and select a book, blog, or forum that is recommended there.

As for buying low & selling high, there is a way for individual investors to do this.  It is quite simple. It is called rebalancing.

Rebalancing is realigning the asset classes of a portfolio.  Over time, a portfolio asset allocation will change because asset classes will perform differently.  Small cap stocks might perform well, while international stocks might have negative returns.  That will change the asset allocation of a portfolio.  Rebalancing is performed by buying or selling asset classes periodically based on the performance of those asset classes within a portfolio.

For example, let’s assume that an investor has a portfolio that is made up of 3 mutual funds.  The portfolio has 40% of its holdings in a bond fund, 20% in a total international stock fund, and 40% in a total U.S. stock fund.  One year later, the investor reviews their asset allocation.  Based on market performance the bond fund is still at 40% of the portfolio, but the international fund has dropped to 15%, while the U.S. stock fund grew to 45% of the portfolio.

To return this portfolio back to its desired asset allocation, the investor must rebalance the portfolio.  They must sell off 5% of the U.S. stock fund and exchange or buy 5% in the international fund.  That is simply selling the U.S. stock fund high and buying the international fund low.

How often should rebalancing occur?  Most experts suggest at least once per year.  I review my portfolio twice per year and rebalance at that point if it is needed.  Some investors do it quarterly.

When do you know it is time to rebalance?  A very simple approach is to set up rebalancing bands.  I follow a +/- of 5% rule.  As in the previous example, if an asset class is off by 5%, I will make the needed exchanges to sell high and buy the lower priced asset class.

Even though this is more structured than trying to know when to make a trade based on the headlines in the media, it is still difficult.  It is difficult because of psychology.  It requires an investor to sell an asset class that is performing well and exchange it for an asset class that is performing poorly.  It is hard for the brain stem to realize that the poor performing asset class of today will be a market leader in the future.

If an investor struggles with pulling the trigger to rebalance their holdings, there is a solution.  Many investment companies have an automated rebalancing feature.  Today, most 401K plans have an automated rebalancing feature.  It is as simple as selecting the percentage bands and frequency.  This allows investors to bypass the psychological barrier of selling off the asset call that is growing for the asset class with recent negative returns.

If you want your portfolio to have high returns while reducing risk, buy low and sell high.  The simplest way for the individual investor to do this is to periodically rebalance their portfolio.  Based on percentage bands an investor should exchange shares of the best performing asset class for those that are lagging in performance.  If an investor is struggling to follow this process, set it up where it is performed manually.

Please remember to check with a financial professional before you ever buy an investment and to read my Disclaimer page.