Real Questions from Real Subscribers

Q: Do you recommend rebalancing a portfolio that tracks the Buy List when a stock’s weighting rises to 5% or 6%, instead of the targeted 3%?

A: Dear Subscriber,

We don't have a specific recommendation on this because there is no right answer that applies to everyone. The decision about when to rebalance an equity portfolio hinges on at least five issues:

1) How much you pay for trades. Trading costs eat into returns, so the lower your costs, the less drag you’ll get from rebalancing. An investor with a $1 million portfolio and $5 trades can rebalance frequently without having much effect on returns. A man with a $25,000 portfolio and $20 trades must be more cautious. Ten rebalancing trades in a year equates to costs of 0.005% for the first investor but 0.8% for the second investor. Only you can determine whether the benefits justify the cost.

2) How comfortable you are deviating from your target asset allocation.

3) How important it is to closely match the returns of your target portfolio.

4) How much risk you can tolerate. If you’re likely to panic and sell if the stock dropped 10%, you might be better off trimming now.

5) How much you like the stock. It may make sense to hold an overweight position in one of your favorite companies. However, if the position is overweight simply because the stock has outperformed, and you don’t think more highly of this stock than others in the portfolio, it makes less sense to hold it.

Thanks for your interest,

Bob Sweet, CFA
Managing Editor, Dow Theory Forecasts

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