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When should you rebalance your portfolio?

Once you’ve committed to rebalancing your portfolio to maintain your chosen asset allocation, you need to decide when you’ll do the deed.

As usual, I’m definitely not going to give you a precise plan on how often you should rebalance. I think there’s no perfect answer, and you need to decide for yourself.

That said, the rest of this post will look at the main approaches to deciding how often you’ll rebalance.

Rebalancing at regular time intervals

There are arguments made for rebalancing from every period from daily to monthly to once-a-decade.

For instance, you might decide to rebalance your portfolio according to the calendar – whether it be every six months, or on January 1st every five years, or on your birthday (so you think about your age, perhaps?), or at the end of the tax year when you’ll be looking at your portfolio anyway.

Whenever you choose to rebalance, the method is the same. You regularly trim and add to different assets on the chosen date to move them back towards your ideal allocation – provided is cost effective to do so – even if the allocations have not moved by much.

The big advantage of this method is you have a dispassionate rule to follow, which takes emotion out of your decisions, and keeps your rebalancing divorced from market sentiment.

Rebalancing according to thresholds

Alternatively, you might rebalance only when certain thresholds are passed. You could check your portfolio periodically, but only rebalance if any asset class has exceeded its allocation by some percentage limit, or has fallen too far.

Here your rebalancing brings big divergences back towards your chosen asset allocation. Small fluctuations are ignored.

For instance, you check your portfolio in March and find you’re overweight in domestic equities by 5%. You ignore this. By December the position has grown to 16% overweight when compared to your chosen asset allocation proportions. You’ve set 10% as your limit, so this time you rebalance by selling down your equities and re-investing in other assets as appropriate.

This method can save time and dealing costs, while still giving you the advantage of a mechanical rule to follow.

Rebalancing according to ‘gut feel’

Now for something completely different.

Purists will frown, but it’s definitely true that many experienced investors choose to rebalance only when they get frightened about extreme divergences in their portfolio. This has been my own approach.

In this method, you simple let assets rise and fall as they will, but crucially you do pay attention to how each asset’s allocation within the portfolio is changing.

When any asset’s divergence gets big enough to scare you or shrinks enough to tempt you into topping up that asset, you do so.

While this method certainly doesn’t have the big advantage of the previous methods in automating your rebalancing, it is still better than doing what 99% of investors do, which is ignore asset allocation altogether.

Rebalancing according to complicated science

There has been some academic research into optimal rebalancing frequencies. Some of this has even leaked out into the wider world of humble investors like you and me.

I’m pretty skeptical of the value of following academic research based on past data. I’m also not qualified to discuss it.

From what I’ve read and researched though, it’s true to say that rough-and-ready rebalancing gives you most or possibly even all of the benefits, without the disadvantage that you have to pour through financial theory or spend your days buried in a spreadsheet.

People love to make things complicated. It gives them a feeling of security. But there’s nothing certain about investing.

I’d suggest it’s better to remember that than to delude yourself with complicated theories based on backdated research.

You decide what works for you

Even if I was qualified to give a precise scientific rule about rebalancing (I’m not) the fact is the frequency of your rebalancing needs to be tailored to your own aims, portfolio, and temperament, otherwise you won’t stick to your plan.

The worst case scenario is that you ignore rebalancing completely, so don’t set unrealistic goals that you can’t commit to. Rebalancing is too important for most investors to let that happen.

In the next post in this series on rebalancing, I’ll highlight some other factors that may influence how often you rebalance, so subscribe to stay in the loop.

Series NavigationHow to rebalance your portfolioFactors that may influence how and when you rebalance

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{ 1 comments… add one and remember nothing here is personal advice }
  • 1 UKValueInvestor February 22, 2010, 4:19 pm

    The part of my funds that are invested semi-passively are rebalanced annually since I tend not to trust myself unless I have hard rules. But I agree with you that there’s no ‘best way’ without hindsight, and it probably doesn’t really matter that much, just as long as you do it at some point!
    .-= UKValueInvestor on: A value based asset allocation strategy – A minor update =-.

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