Two the Point — When Should I Rebalance My Portfolio?

This week’s content was inspired by a recent client question, as well as a research piece we read about two years ago. We are strong believers in thoughtful and intentional asset allocation, so the question of when to rebalance your portfolio back to its target weights is very important…especially in a volatile market. Interestingly, the answer is that is doesn’t matter when you rebalance, as long as you do it regularly.

The reason investors should rebalance is because, if done properly, your asset allocation should represent the exposures needed to reach return goals, while also being considerate of how much volatility you can live with. At some point the mix of asset classes will stray from the target weights as markets prices change, so being aware of this exposure drift is important. To use an extreme example, if you started with a 60/40 stock/bond mix in 1926, by 2020 your bond allocation would essentially be 0% because stocks outperformed bonds to such a large degree.

Data supports the notion of systematic rebalancing based on a predetermined month of the year, but interestingly it doesn’t matter which month one chooses. The chart below shows the growth of $1 for a 60/40 portfolio rebalanced every January, February, and so on. They all end up in about the same spot, as you can see in the table that shows the compound annual growth rates. The risk profiles in terms of drawdowns from the portfolios’ highs are also almost identical.

What if we used a deviation threshold as the trigger to rebalance like +/-2% from the target weight? Once again, the result is almost exactly the same as just picking one month per year. What about a +/-5% threshold? Once again, the cumulative return difference is not meaningful.

The bottom line is that rebalancing should not be overthought, and it does not need to be based on precise timing. Simply having and executing a consistent plan (ours is once a year some time in the first quarter) is the most important thing. This will preserve your intended asset allocation while also keeping portfolio activity (and any tax implications) to a minimum.