Last time I discussed why you need to rebalance your stock portfolio and hopefully convinced you that rebalancing is a good and necessary thing.

Discover 3 Common ways to Rebalance your stock portfolio
But how often should you rebalance? And how should you do it?

Right off the bat let me say there is no one way everyone agrees is best, but there are better ways and worse ways. So let’s analyze some rebalancing methods and see where we end up.

It should be obvious that because stock prices change all the time, portfolios filled with stocks will usually be out of balance. However it doesn’t make sense to constantly rebalance because buying and selling cost you time, having to constantly look at your portfolio, and money, in the form of transaction fees and taxes.

Because of this, the most common type of rebalancing is calendar rebalancing. You choose a time, say every 3 months, 6 months or annually, and rebalance at that point in time. The actual period doesn’t matter much and although there’s been loads of research done, nothing conclusive has been determined.

Perhaps for that reason, most investors choose to rebalance annually. It’s usually beneficial to rebalance when you’re about to add money to your portfolio, such as when you’re contributing to a retirement account or investing your tax refund, so the annual date you choose should take this into account, but otherwise any date will do.

The benefit of calendar rebalancing is that it’s simple to do and simple to understand.

The downside is this type of rebalancing is very inefficient. Your portfolio will usually be out of balance most of the year and you won’t be able to take consistent advantage of the benefits I discussed in my last article, namely risk reduction, improved returns and efficiently buying low and selling high.

However calendar rebalancing is better than what most people do, which is, not rebalancing at all.

A more effective rebalancing method is to use thresholds. The idea is to only rebalance when a stock drifts off target by a certain percentage, say an absolute 5% or a relative 25%.

For example, if one of your stock holdings has a target allocation of 20%, you would rebalance if its target allocation fell below 15% or rose above 25% (that is, an absolute 5%).

Or you could choose to rebalance using a relative 25%. So if your stock’s allocation is, say, 10%, you would rebalance whenever the allocation rose above 12.5% or fell below 7.5% (because 2.5% is 25% of 10%).

Either method works but most people find using a relative number is better for smaller holdings (say when a stock comprises 15% or less of your portfolio) and an absolute number for larger holdings (above 15%).

The advantage of threshold rebalancing is, since it depends on price, you capture more rebalancing opportunities than with the simple calendar rebalancing method. On the other hand it’s not so good if you hold lots of stocks in your portfolio because it has a tendency to rebalance based on small moves. However if you stick with selecting 10 or so well-chosen stocks, as I normally recommend, threshold rebalancing is a good way to go.

The disadvantage of this method is it takes more time. You have to constantly monitor your portfolio rather than simply look at it once a year. However with today’s easily accessible software and spreadsheets, threshold rebalancing doesn’t take as much time and effort as it did just a decade ago.

Another, less common, rebalancing method is to only rebalance when you’re adding new money to your portfolio or making a withdrawal. In this instance you add money to the underperforming stocks or sell an over-performing stock to take money out. I personally don’t think this is a good way to rebalance, but it is better than doing nothing.

These three rebalancing methods are what most people who rebalance use; however the sad fact is most investors don’t rebalance at all. So if you’re doing any sort of rebalancing, you’re light-years ahead of your investing colleagues.

So which method should you use? Which do I recommend?

None of them.

If you’re surprised by that answer, hang on a second. In my next article I’ll describe what I believe to be a superior rebalancing method. It’s called Opportunistic Rebalancing and has a number of advantages over all the methods I’ve just discussed.

Stay tuned and I’ll see you then.

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