THE BLOG
12/03/2012 08:20 am ET Updated Feb 02, 2013

How Often Should I Rebalance My Investments?

Investment experts will tell you that the keys to successful investing are diversification and rebalancing. This means that (1) you should buy a diverse collection of stocks and bonds and (2) you should maintain the percentage of your money of each. Diversification guards against large fluctuations in certain industries or sectors. The value of rebalancing is a bit more subtle. Here's how it works: If a stock goes down, its dollar percentage of your portfolio goes down, so to maintain the fixed percentage, you have to buy more of it. Similarly if a stock goes up, its dollar percentage of your portfolio goes up, so to maintain the fixed percentage you have to sell some of it. This kind of "rebalancing" means that you buy stocks when they're down and sell them when they're up, and that's how you make more money. The average investor buys more of a stock when it goes up and sells it when it goes down, and that's how he loses money. Note that index funds don't rebalance like this for you; they have a fixed share percentage in each asset instead of a fixed dollar percentage.

A student in my Investment Mathematics class asked me how often you need to rebalance. The most common guideline we found was "at least once a year," but we knew that the answer should depend on the value V of your portfolio, because transaction costs make rebalancing relatively more expensive for the small investor. The student, Walter Filkins, and I ended up writing a little paper with a derivation of our own rule of thumb:

For a portfolio of value V, let a be the cube root of 15000/V, and rebalance every a years.

So if you have $15,000, rebalance every year. If you have $120,000, rebalance every
six months. If you have $1 million, rebalance every three months. If you have $25 million, rebalance every month. If you have $1 billion, rebalance every nine days. If you have $1 trillion, rebalance every day.