How to Rebalance Your Boglehead Portfolio: A Simple, Once-a-Year Tutorial

Introduction

Investing can feel like a complicated world filled with jargon, “hot tips,” and constant noise. But what if you could build wealth using a simple, proven, and low-stress strategy? Welcome to the world of Boglehead investing.

The beauty of this philosophy is its simplicity. You create a diversified, low-cost portfolio and then… you mostly leave it alone. But “mostly” is the key word. Your portfolio needs an annual check-up, a quick tune-up to make sure it’s still aligned with your goals. This process is called rebalancing, and it’s far simpler than it sounds.

This guide will walk you through everything you need to know, from the basic building blocks of investing to the simple, step-by-step process of rebalancing your portfolio once a year.

The Building Blocks: Key Investing Terms Explained

Before we dive into strategy, let’s get on the same page with a few essential terms.

• Mutual Fund: Think of it as a big pot of money collected from thousands of investors. A professional manager uses this money to buy a wide variety of investments, like stocks and bonds. This instantly diversifies your investment, meaning you own tiny pieces of many companies.
• Index Fund: This is a special, low-cost type of mutual fund. Instead of trying to pick winning stocks, it simply aims to match the performance of a market index. It’s a passive approach that buys all the stocks or bonds in a specific index.
• S&P 500: The Standard & Poor’s 500 is a market index that represents the 500 largest publicly-traded companies in the United States. An S&P 500 index fund lets you own a small slice of all of them, from Apple to Amazon.
• Expense Ratio: This is the annual fee you pay a mutual fund or index fund for managing your money, expressed as a percentage of your investment. A 0.50% expense ratio means you pay $5 for every $1,000 invested. For Bogleheads, the lower, the better.

The Core Debate: Passive vs. Active Investing

Every investment strategy falls into one of two camps: active or passive.

Active Investing is the attempt to “beat the market.” Active fund managers and stock-pickers research, analyze, and trade frequently, trying to buy low and sell high. This approach comes with higher fees (to pay for the research and trading) and, for most, a disappointing track record.

Passive Investing is the decision to “be the market.” Instead of trying to beat it, you simply buy a broad slice of the market through a low-cost index fund and hold on. The goal is to capture the market’s natural long-term growth.

So, which one works better? The data is overwhelmingly clear. Over the long term, the vast majority of active funds fail to beat their passive benchmarks.

Percentage of Active Funds Underperforming Their Benchmarks (over 15 years)

Source: S&P Indices Versus Active (SPIVA) Mid-Year 2023 Report.

This is the central insight of the Boglehead philosophy: why pay high fees for a strategy that is very likely to underperform a simple, low-cost index fund?

Introducing the Boglehead Philosophy

Named after John C. Bogle, the founder of Vanguard, the Boglehead philosophy is a set of simple, powerful principles for investment success.

1. Develop a Sensible Plan: Decide on your target asset allocation—the mix of stocks and bonds in your portfolio—based on your goals, time horizon, and risk tolerance.
2. Diversify Broadly: Don’t try to find the needle in the haystack. Just buy the whole haystack. Own thousands of stocks and bonds from around the world through low-cost index funds.
3. Keep Costs Low: Fees are a silent portfolio killer. Bogleheads obsess over low expense ratios because every dollar you save in fees is a dollar that stays in your pocket, compounding over time.
4. Stay the Course: This is the most important rule. Ignore the daily market news, the fear, and the greed. Stick to your plan through good times and bad.

The Simple 3-Fund Portfolio

The Boglehead philosophy shines in its practicality. The most popular expression of this is the three-fund portfolio, which gives you broad diversification with incredible simplicity.

Here are the three components:

1. A U.S. Total Stock Market Index Fund: Owns a piece of virtually every public company in the United States. (Example tickers: VTSAX, VTI)
2. An International Total Stock Market Index Fund: Owns a piece of thousands of companies outside the U.S. (Example tickers: VTIAX, VXUS)
3. A U.S. Total Bond Market Index Fund: Owns thousands of high-quality U.S. government and corporate bonds, which act as a stabilizer for your portfolio. (Example tickers: VBTLX, BND)

That’s it. With just three funds, you have a globally diversified portfolio. Your personal asset allocation might look something like this:

• A 30-year-old investor: 60% U.S. Stocks, 20% International Stocks, 20% Bonds.
• A 55-year-old investor nearing retirement: 40% U.S. Stocks, 10% International Stocks, 50% Bonds.

Your Simple, Once-a-Year Rebalancing Tutorial

Now for the main event. Your portfolio is set up, and a year has gone by. You notice that stocks had a great year, while bonds were flat. Your perfect 60/20/20 allocation is now something like 65/18/17.

Why rebalance? Rebalancing is the process of bringing your portfolio back to its original target allocation. It forces you to follow the golden rule of investing: buy low and sell high. By selling some of the asset that performed well (selling high) and buying more of the asset that underperformed (buying low), you manage risk and maintain discipline.

Here’s how to do it in four simple steps.

Scenario:

• Your Target Allocation: 60% U.S. Stocks, 20% International Stocks, 20% Bonds.
• Initial Investment: $10,000.

Step 1: Know Your Target

Your initial portfolio was perfectly balanced:

• U.S. Stocks: $6,000 (60%)
• International Stocks: $2,000 (20%)
• Bonds: $2,000 (20%)

Step 2: Check Your Current Allocation

After one year, the market has moved, and your portfolio is now worth $12,000.

• U.S. Stocks grew to $7,800.
• International Stocks grew to $2,200.
• Bonds stayed flat at $2,000.

Your new, drifted allocation is:

• U.S. Stocks: 65% ($7,800 / $12,000)
• International Stocks: 18.3% ($2,200 / $12,000)
• Bonds: 16.7% ($2,000 / $12,000)

Your portfolio is now overweight in U.S. stocks and underweight in the others. It’s time to rebalance.

Step 3: Calculate the Difference

Based on your new total of $12,000, your targets are:

• Target U.S. Stocks: $12,000 x 60% = $7,200 (You have $7,800, so you’re $600 over).
• Target International Stocks: $12,000 x 20% = $2,400 (You have $2,200, so you’re $200 under).
• Target Bonds: $12,000 x 20% = $2,400 (You have $2,000, so you’re $400 under).

Step 4: Rebalance!

You have two simple ways to do this:

• Method A: Sell to Buy (Best for retirement accounts like a 401(k) or IRA) Sell $600 of your U.S. Stock fund. Then, use that money to buy $200 of your International Stock fund and $400 of your Bond fund. Your portfolio is now back to its 60/20/20 target.

• Method B: Use New Contributions (Best for taxable brokerage accounts) If you’re regularly adding money to your portfolio, simply direct your new contributions to the underweight assets. In our example, you would put your next $600 of contributions toward your International Stock and Bond funds until they catch up. This method avoids selling and potentially triggering capital gains taxes.

Common Pitfalls and How to Avoid Them

The Boglehead strategy is simple, but it isn’t always easy. The biggest challenges are psychological.

1. Market Timing: Don’t try to guess when the market will go up or down. Nobody can do it consistently. Your rebalancing plan is your automated, logical guide.
2. Emotional Decisions: It feels scary to buy stocks when the market is crashing, but that’s exactly what rebalancing forces you to do. Conversely, it trims your winners when everyone is euphoric. This discipline is your greatest advantage.
3. Forgetting the “Why”: Remember that you are a long-term investor, not a trader. You are building wealth over decades, not days. Stay the course.

Conclusion

Building a successful investment portfolio doesn’t require a finance degree or a crystal ball. It requires a simple, sensible plan that you can stick with. The Boglehead three-fund portfolio gives you that plan.

Rebalancing is the simple annual maintenance that keeps your plan on track. It’s a disciplined, unemotional process that manages risk and sets you up for long-term success. By following this once-a-year tutorial, you can take control of your financial future and let the power of the market work for you.