Before analyzing how often investors should rebalance, it’s important to determine the significance of why one should consider rebalancing. As a fee-only financial planner in the Austin, TX metro area, not understanding the importance of rebalancing is where I see many investors go wrong.
How Often Should Investors Rebalance?
The goal for rebalancing is to minimize risk for the portfolio relative to your financial goals. Asset classes and sectors produce different rates of returns that go in and out of favor. If positions aren’t rebalanced, investors are taking unnecessary market risk.
Some investors acknowledge taking additional risk by choosing not to rebalance as a strategy to outperform the market called the “set it and forget it” strategy. This strategy can be good on the wallet for investors with a long-term time horizon because it limits transaction costs. When it comes to performance, “set it and forget it” makes portfolio allocations more aggressive with a higher equity portion over time which generates a better rate of return. Outside of this select group of long-term risk takers, the strategy generally is not the answer.
Some investors are worried of the additional costs that come from rebalancing. Rebalancing costs include taxes for capital gains, transaction costs and the opportunity cost of the time and effort needed to manage a portfolio.
- Background: The only variable taken into consideration for this rebalancing strategy is time. The time in between rebalancing can be done in different intervals such as once a month, once a quarter, semi-annually or annually.
- Pros: This should be easy to implement as it’s based on a timed schedule. The key to this strategy is having the discipline to continue hitting the trigger to rebalance at the right time.
- Cons: This strategy does not take into consideration how much or how little the asset allocation has drifted from the target. This may result in higher trading costs if the portfolio is close to the target allocation.
- Background: The only variable taken into consideration for this rebalancing strategy is asset allocation. The portfolio is rebalanced any time it deviates more than a predetermined percentage from the target allocation such as 5 or 10%. This rebalancing strategy disregards the frequency of a time-based rebalancing strategy.
- Pros: This should be easy to implement as it’s based on predetermined rules for a target asset allocation of a portfolio. The key to this strategy is having the discipline to continue hitting the trigger to rebalance as the allocation hits the target.
- Cons: This may cause the portfolio to rebalance too often or not enough. There is no proven method to time the top or bottom of the market.
Time and Threshold
- Background: This rebalancing strategy combines considerations used from time only and threshold only strategies. The portfolio is rebalanced if the target asset allocation deviates from the target allocation by the predetermined amount on a timed schedule.
- Pros: This rebalancing strategy can keep transactions costs and capital gains lower than utilizing a time or threshold only strategy.
- Cons: This rebalancing strategy takes more time and effort to utilize effectively. It has not statistically proven to be better or worse than other strategies.
Finding the Right Rebalancing Strategy
Vanguard’s Best Practices for Portfolio Rebalancing concludes that there is no optimal rebalancing strategy. While there is no optimal strategy, they still recommend choosing a rebalancing strategy based on reasonable monitoring frequencies and allocation thresholds.
For Safe Landing Financial, I review rebalancing decisions on a quarterly basis and determine whether the portfolio should be rebalanced or not. If market volatility pushes a portfolio too far from the predetermined asset allocation tailored from the customized financial plan, I rebalance the portfolio. If the allocation is within the parameters of the financial plan, I tend to hold off on rebalancing the portfolio, but may make minor changes. In the end, finding the right rebalancing strategy should be based on your financial plan, investment philosophy and limiting downside risk.
Kitces.com: Finding The Optimal Rebalancing Frequency – Time Horizons Vs Tolerance Bands
Fee-Only Financial Planner in Austin, TX Metro (Including Round Rock, Cedar Park, Georgetown and Pflugerville)
Still have questions in how to determine the right rebalancing strategy? Safe Landing Financial is a fee-only financial planner located in Austin, TX. We offer in-person financial planning in Austin, Round Rock, Cedar Park, Georgetown and Pflugerville and virtual financial planning nationwide.