Method 3 Rebalancing

The Fundranker system is based on allocating your investments equally across all eight funds in the Top Eight Model Portfolio. We discuss three methods you can use to rebalance your portfolio on our FAQ page. In this post, we’ll discuss Method 3 further. See our posts on Method 1 and Method 2 for further examples.

It is important to note that Method 3 rebalancing involves selling shares from some of your funds that you may not be exchanging otherwise, so consider tax consequences before you use it to balance your taxable accounts. You will realize whatever capital gains or losses those shares have made since you bought them. You may decide that leaving your taxable funds less balanced is better than realizing capital gains earlier than necessary.

Method 3 rebalancing opportunities occur every month on the Fundranker exchange date. Here is an example of Method 3 rebalancing for our upcoming April 5, 2010, exchange date:

Let’s assume that, as of the close on April 1, 2010, you hold the following:

First, on April 5, 2010, calculate your goal amount to balance your funds: (5,500 + 6,500 + 7,100 + 5,400 + 6,100 + 7,200 + 5,100 + 6,700) / 8 = 6,200

Second, determine which funds you can exchange from. All of your funds will have been held at least 30 days as of April 5, thus avoiding roundtrip transactions. For this example, let’s assume you are balancing funds in an IRA account (see the Fundranker blog post about Fidelity minimum initial investments). FSRFX, FSPTX, and FSELX are at least $500 above your goal amount.

Third, determine which funds you can exchange to. For this example, let’s assume that FSDCX, FSPTX, FSRPX, and FSELX fell out of the Top Eight Model Portfolio and will be exchanged to new funds on April 5. Only FSRPX is more than $500 below your goal amount.

Fourth, enter your balancing exchanges at Fidelity Investments. Before 4pm ET on April 5, exchange $1,000 from FSPTX to the new fund for FSRPX.

Finally, also enter your regular exchanges at Fidelity Investments before 4pm ET on April 5. When you enter your exchange from FSPTX to its replacement, Fidelity will warn you that you already have an outstanding exchange for FSPTX, which is okay—it’s your balancing exchange from step four. One of your regular exchanges will be from FSRPX to its replacement. Fidelity automatically will combine your balancing and regular exchanges to the replacement fund for FSRPX into one position.

Note that although you usually will rebalance only part of your funds using Method 3, it still helps bring your funds closer to being balanced, and you can repeat it frequently.

Posted 3/30/10 5:40pm ET in Fundranker

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