The Rebalancing Act: Managing Your Investments

Chart: Where to Invest Your Money

Want More Details? Here are some funds from TIAA-CREF and Vanguard that Swensen recommends.

Domestic Equity: Vanguard Total Stock Market Index Fund (VTSMX); TIAA-CREF Instl Equity Index Retail (TINRX)

Foreign Equity: Vanguard Total International Stock Index Fund (VGTSX); TIAA-CREF Instl International Eq Retail (TIERX)

Emerging Markets: Vanguard Emerging Markets Stock Index Fund (VEIEX)

REITs: Vanguard REIT Index Fund (VGSIX); TIAA-CREF Instl Real Estate Sec Retail (TCREX)

Government Bonds:

— Vanguard Short-Term Treasury Fund (VFISX); TIAA-CREF Inst Short-Term Bond II Retail (TCTRX)

— Vanguard Intermediate-Term Treasury Fund (VFITX); TIAA-CREF Instl Bond Retail (TIORX)

— Vanguard Long-Term Treasury Fund (VUSTX)


TIPs:

— Vanguard Inflation-Protected Securities Fund (VIPSX); TIAA-CREF Instl Inflation Link Bd Retail (TCILX)

So you've set up your investment portfolio according to the mix recommended by Yale's David Swensen. Now what? Remember to rebalance.

Rebalancing: A Free Bonus

When is it time to rebalance? Swensen says people should rebalance their retirement accounts at least quarterly — four times a year. He says the technique is a disciplined way to buy low and sell high over time. It also keeps your risk profile where you want it to be.

But investors should always try to avoid transaction fees. Even some nonprofits like TIAA-CREF may charge extra trading fees if an investor rebalances more than a certain number of times a year.

Swensen rebalances Yale's endowment every day. Yale's endowment has in some instances earned upwards of $1 million in a single day — just by rebalancing. Individual investors won't make that much, but it shows the power of rebalancing. Even if the overall stock market doesn't show a gain, you can goose out extra returns this way.

Timing Is Everything

Here's how it works: Let's say an investor has allocated their investments according to Swensen's basic formula (30 percent in U.S. stocks, 30 percent bonds, 20 percent real estate investment trusts, etc.) and the U.S. stock market falls over a couple of months. With U.S. stocks falling, stocks may now make up only 28 percent or 29 percent of the 401K pie chart.

But perhaps bond holdings have risen over the same time period, from the target 30 percent to 31 percent or 32 percent. Then it's time to rebalance by selling some shares in the bond funds and using the proceeds to buy more stock index funds, bringing both categories back into line with long-term allocation targets.

If stocks come roaring back in a month, an investor would own more stocks and make more money on the gains. If stocks jump up to 31 percent or 32 percent in the model portfolio, then an investor would sell stocks high and buy something else — real estate, bonds or whatever has decreased its share of the 401K.

The Tax Factor

Swensen can rebalance Yale's endowment frequently because Yale is tax-exempt. But if an individual invests savings outside of a 401K or other tax-deferred account, he or she needs to be aware that rebalancing can create tax liabilities. One way to avoid that is to do rebalancing only in the tax-deferred portion of a portfolio. New contributions may also be used as rebalancing tools, so that investors sell fewer existing investments.

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