Rebalancing

Most investors know that to be successful, you have to buy low and sell high. Unfortunately, most investors do just the opposite. They tend to buy yesterday’s winners after they have already gone up and sell their losers after they have already gone down out of fear of losing more. Employing a rebalancing strategy adds discipline and removes the human emotion from investing.

Each year some asset classes in your portfolio will under-perform and some asset classes will over-perform. A rebalancing strategy ensures that you buy low and sell high. Each time you rebalance your portfolio, you are selling some of the asset classes that have done well and buying some of the asset classes that have done worse. This keeps your portfolio in line with your risk preference and eliminates irrational behavior that human emotions often lead to.

On a macro level, rebalancing is kind of like the "management" of passive investing. Over time asset classes will drift away from their initial allocation percentage and will need to be adjusted back to the original weighting. See below for an example.

A successful rebalancing strategy is decided upon before you invest. Some investors believe they should rebalance at specified time intervals such as quarterly, semiannually, or annually. Others utilize tolerance based formulas where they rebalance when an asset class gets larger/smaller than the initial allocation regardless of how much time has passed.

The research as to which method of rebalancing is more effective is mixed. Interval rebalancing does better during some time periods and tolerance based rebalancing does better during other time periods with no discernable pattern as to which method will work best next.

If you rebalance too often (i.e. daily), the added expenses will outweigh the benefits. If you rebalance too infrequently, your portfolio’s composition can change considerably which means the risk will change considerably. You want to let your portfolio get out of balance enough to benefit from rebalancing without subjecting yourself to more risk than you are comfortable with.

Our normal protocol is to review allocations quarterly and rebalance annually, if needed. If a client has more than one account, we rebalance each account rather than across all accounts. We have found that investing several accounts as one portfolio makes it more difficult for clients to track performance and also introduces some of the emotional aspects rebalancing eliminates. If a client sees one account perform much better than another, they may be tempted to invest every account in the same fashion. We may also rebalance after periods of extreme volatility as well as when money is added or removed for your account.