To reduce the psychological pressure, we do not want to modify the amount of money committed to investment beyond the monthly saving/using rate.
Instead we use rebalancing tactics.
The idea is pretty simple. If we have a portfolio of assets, we could improve the alpha of the portfolio (risk-adjusted reward) by combining uncorrelated bets.
If we sell an asset within some class of assets, we can buy a more successful asset within the same class of assets.
If some class of assets under/over-performs the allocation by more than 20% of its allocated size, it is balanced back to reflect the ideal allocation.
We do rebalancing on several levels.
The table below is illustrative, and not the actual table we use:
1. For the whole portfolio define allocation to different kinds of assets by trading speed (and risk level):
1a. Swing-trading assets [20%]
1b. Position trading assets [30%]
1c. Buy-and-hold assets [30%]
1d. Cache-equivalent assets [20%]
We add/remove money to keep all the components around predefined rates approximately monthly.
For each risk level we keep rebalancing according to risk level
2. Swing-trading assets are rebalanced daily around opportunities. The diversification is not predetermined, but no asset should take more than 5% from this risk basket.
2a. Leveraged US indices [bull/bear] and volatility.
2b. Leveraged international indices
2c. Leveraged industry sectors
2d. Leveraged commodities
2e. Leveraged forex
All assets in this basket are to some extent correlated with each other and there is no reasonable way to decorrelate them, so the risk within the basket is inherently high. Most of the monthly rebablancing will go for this particular basket. Each asset in this basket can get status of Leveraged/Long/Shy/Inverse/InverseLeveraged.
It does not make sense to hold highly leveraged volatile assets outside of this basket due to inherent costs of leverage.
3. Position trading assets are rebalanced weekly. An asset is rebalanced if it breaks long-term trait. The assets are allocated a-priori diverse, but no special care is taken to increase the diversity
3a. Individual stocks [30%], growth. or aristocrats
3b. Individual sectors/international [30%], the outperforming candidates
3c. Alternative assets [30%], REIT/MLP/preferred/….
3d. Speculative [10%], TBD opportunistic
4. Buy-and-hold assets should not be rebalanced often, but should counteract biases of the other investment classes
4a. Treasury bonds [40%]
4b. Diversified allocation or close end funds [30%]
4c. Rule-based trading [30%]
5. Cache-equivalent should be rebalanced to reflect monetary risks:
5a. External bank account – drawdown mitigation.
5b. Internal cache reserves – to cover fees and use opportunities
5c. Forex, gold and inflation investments – to reflect USD strength
6. Multi-account allocation. The trading may happen on multiple accounts (main broker account, multiple IRA accounts, …) and is backed up by the main banking accounts.
There may be a need of rebalancing money between various accounts.