Finance When to rebalance OK, once you understand the strategic rationale for rebalancing the portfolio, the next question becomes: when should you do it? For some institutional investors (mostly pensions and other large pooled funds), the answer is, every day. But for the retail investor, such constant tweaking of the portfolio can be expensive ‒ it costs money to buy and sell, and the more of that you do, the more of your investment gains will be eaten up in fees to your broker or wealth manager. That’s why it’s often better to choose one of the following approaches: Set-date approach Perhaps the most common rebalancing strategy is to make adjustments on a regular schedule ‒ say, once a year, or quarterly, or monthly ‒ without too much concern for how much the portfolio has drifted away from its original allocation target. Is there one interval that’s better than any other? Not really. There have been plenty of studies (including fromwell-respected asset manager Vanguard Inc.) that have used historical data to determine exactly how often you should rebalance. Results determined that there’s really not much performance difference between annual, monthly or quarterly rebalancing. Traditionally, the time to reallocate was always the end of the year, because that’s the time when big institutional clients and professional money managers tend to sell their losers and rebalance to their published allocation targets. This, in large part, is because capital losses must be “booked” by the end of the year if the investor wants to claim the loss on next year’s tax return. No reason why the “little guy” can’t do the same. Remember that if you’re rebalancing a registered account (your RRSP, RRIF or TFSA), you won’t be able to claim tax losses anyway, so this rationale doesn’t really apply. On a personal side, rebalancing once a year also has a certain “Goldilocks” quality. It’s an interval that’s not so frequent that rebalancing becomes a burden, but it’s not so long that the lack of rebalancing allows problems in the portfolio to fester. But there’s no reason why you can’t choose some other interval if that fits your life a little better. In fact, many investors choose to rebalance during the summer months, when life is a little less hectic and they have a little more time to focus on money matters, and when the markets tend to be a little less frenetic than they can be at the end of the year. Set-threshold approach With this approach, the exact time or frequency of the rebalancing effort matters less than the amount of deviation from the portfolio’s original allocation target. Any time a given asset deviates by more than a set percentage (say, 1%, or 5%, or 10%, etc.), it’s trimmed back and the proceeds are reallocated to other assets. So, for example, if you have a 50% base allocation to equities and, during the first half of the year, equities deliver a 10% return, your equity allocation will now be 55% (assuming that all other assets remain flat for the year). In this case, you trim back your equity allocation to 50% and distribute the proceeds to other assets. If equities suddenly suffer a 10% correction the following month, you would trim back your exposure to other assets and reallocate to equities, bringing things back up to 50% again. How much deviation should you allow? Again, academic studies showed very little performance benefit between 1% and 10% intervals ‒ so the question is really one of personal preference. Perhaps the main consideration is howmuch you like to keep an eye on your portfolio. A lower threshold will suit those who like to stay on top of things, while a higher threshold is a better fit for the investors who likes to “set it and forget it” when it comes to the portfolio. Combination approach Because of the limitations of both of the above approaches, perhaps the best solution is to combine them ‒ to rebalance the portfolio based on a predetermined schedule (annually, monthly, quarterly, etc.) but only if given assets have strayed from their original allocation by a minimum percentage (5%, 10%, etc.). Such an approach may offer the “best of both worlds.” It’s more nuanced than the set-date approach, because it also accounts for the possibility that it’s not really necessary to rebalance if the amount of an asset’s drift from its original target allocation is relatively low. In practical terms, the combination approach eliminates some transactions that would be necessary in a period of heightened volatility, because an asset returns to its target threshold in short order. 30 | www.snowbirds.org
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