How Often Should You Rebalance a Portfolio? [Empirical Results]
As a long-term investor, one of the important aspects of managing your investment portfolio is maintaining the right balance between various assets and asset classes.
The aim is to achieve an allocation that generates enough expected return while keeping risk at an acceptable level.
To maintain this balance, you need to periodically rebalance your portfolio.
In this article, we’ll look at how often you should rebalance your portfolio, the benefits of rebalancing, and the various considerations involved in the process.
Key Takeaways – How Often Should You Rebalance a Portfolio?
- Maintaining the right balance between assets and asset classes is essential for long-term investors to manage their investment portfolios effectively.
- Rebalancing your portfolio periodically is necessary to realign the asset allocation with your desired allocation and manage risk exposure.
- The optimal frequency for rebalancing depends on your individual goals, risk tolerance, and costs associated with rebalancing.
- We ran an experiment and found that annual rebalancing showed slightly better results in terms of risk-adjusted returns than other time-based and performance-based rebalancing approaches.
- Overall, consider tax implications and choose a rebalancing method that suits your needs.
Understanding Rebalancing
Rebalancing is the process of adjusting your portfolio’s asset allocation to bring it back in line with your desired allocation.
As market conditions change and different assets perform differently, your initial allocation can drift away from your desired allocation.
This can expose you to more risk or reduce your potential returns.
Rebalancing also helps you to sell what’s risen in value (relatively speaking) and buy what’s fallen in relative value. This is generally a good idea because of the value considerations involved in doing so.
The Frequency of Rebalancing
Time-based Rebalancing
Some financial experts recommend rebalancing your portfolio at regular intervals, such as annually or quarterly.
This approach is simple to follow and helps keep your portfolio aligned with your investment goals.
However, it might not be the most optimal in terms of minimizing risk or maximizing returns.
Threshold-based Rebalancing
Another approach is to rebalance your portfolio whenever the allocation of a particular asset class deviates from its target allocation by a predetermined percentage, such as 5% or 10%.
This method is more responsive to market movements and can help you to capitalize on opportunities or minimize risk more effectively.
However, a threshold-based approach may require more frequent monitoring and adjustments, leading to increased transaction costs and potential tax implications.
Which is better – rebalancing monthly, quarterly, semi-annually, annually, based on thresholds? Or not rebalancing at all?
We ran a test to find out.
We took the following allocation (a reasonably balanced portfolio) from 1972 to today:
- 30% US stocks
- 45% 10-year US Treasuries
- 10% Cash
- 15% Gold
And rebalanced it:
- Monthly
- Quarterly
- Semi-annually
- Annually
- Based on performance thresholds
- Never rebalancing
To see which performed best from the perspective of risk-adjusted returns and simple overall performance.
Here are the results:
Rebalanced Monthly
| Portfolio | Initial Balance | Final Balance | CAGR | Stdev | Best Year | Worst Year | Max. Drawdown | Sharpe Ratio | Sortino Ratio | Market Correlation |
|---|---|---|---|---|---|---|---|---|---|---|
| Monthly | $10,000 | $570,708 | 8.20% | 6.99% | 27.69% | -12.51% | -15.91% | 0.53 | 0.82 | 0.72 |
Rebalanced Quarterly
| Portfolio | Initial Balance | Final Balance | CAGR | Stdev | Best Year | Worst Year | Max. Drawdown | Sharpe Ratio | Sortino Ratio | Market Correlation |
|---|---|---|---|---|---|---|---|---|---|---|
| Quarterly | $10,000 | $601,412 | 8.31% | 7.01% | 27.67% | -12.62% | -15.94% | 0.54 | 0.84 | 0.71 |
Rebalanced Semi-Annually
| Portfolio | Initial Balance | Final Balance | CAGR | Stdev | Best Year | Worst Year | Max. Drawdown | Sharpe Ratio | Sortino Ratio | Market Correlation |
|---|---|---|---|---|---|---|---|---|---|---|
| Semi-Annually | $10,000 | $605,487 | 8.32% | 7.02% | 27.88% | -12.59% | -15.88% | 0.54 | 0.85 | 0.70 |
Rebalanced Annually
| Portfolio | Initial Balance | Final Balance | CAGR | Stdev | Best Year | Worst Year | Max. Drawdown | Sharpe Ratio | Sortino Ratio | Market Correlation |
|---|---|---|---|---|---|---|---|---|---|---|
| Annually | $10,000 | $635,025 | 8.42% | 7.08% | 28.13% | -12.65% | -15.89% | 0.55 | 0.86 | 0.70 |
Rebalanced Based on Performance Thresholds
This experiment was run based on whether the deviations varied based on the relative allocations changing by more than 5%.
| Portfolio | Initial Balance | Final Balance | CAGR | Stdev | Best Year | Worst Year | Max. Drawdown | Sharpe Ratio | Sortino Ratio | Market Correlation |
|---|---|---|---|---|---|---|---|---|---|---|
| Performance | $10,000 | $578,972 | 8.23% | 7.00% | 27.81% | -12.49% | -15.90% | 0.53 | 0.83 | 0.72 |
We also played around by changing the performance thresholds, but there was little material difference.
Never Rebalanced
| Portfolio | Initial Balance | Final Balance | CAGR | Stdev | Best Year | Worst Year | Max. Drawdown | Sharpe Ratio | Sortino Ratio | Market Correlation |
|---|---|---|---|---|---|---|---|---|---|---|
| Never Rebalanced | $10,000 | $653,085 | 8.48% | 10.13% | 57.75% | -18.17% | -30.91% | 0.42 | 0.63 | 0.69 |
Findings
There was little material difference rebalancing monthly, annually, or somewhere in between.
Rebalancing annually actually seemed to be slightly better based on the metrics.
Rebalancing based on performance thresholds didn’t show improvement relative to a timing-based approach.
The only approach that did worse from a risk-adjusted returns perspective was the “Never Rebalanced” portfolio.
This was because equities have higher returns over bonds, cash, and commodities over the long run, so they dominated the portfolio over time.
This leads to structurally higher volatility, less balance, and lower risk-adjusted returns, though it may lead to better absolute returns.
This also emphasizes that tinkering with your portfolio too much isn’t necessarily a good idea.
Balancing Returns, Risk, and Costs
The ideal rebalancing frequency depends on your specific investment goals, risk tolerance, and the costs involved in rebalancing.
Rebalancing too frequently can result in higher transaction costs and tax liabilities, while rebalancing too infrequently can leave your portfolio exposed to unnecessary risk or reduced returns.
Tax Considerations
When rebalancing your portfolio, it is essential to consider the potential tax implications.
Selling off assets that have appreciated in value may trigger capital gains taxes, which can eat into your returns.
To minimize tax liabilities, consider the following strategies:
Utilize Tax-Advantaged Accounts
If possible, rebalance your investments within tax-advantaged accounts such as IRAs or 401(k)s, where capital gains are deferred or not subject to taxes.
Tax Loss Harvesting
Offset capital gains by selling assets that have experienced losses.
This strategy can help to reduce your overall tax burden while maintaining a balanced portfolio.
Rebalancing Methods
There are different ways to rebalance your portfolio, each with its own benefits and drawbacks:
Selling Off Winners
You can sell assets that have appreciated in value and use the proceeds to purchase assets that have underperformed.
This method is straightforward but may trigger capital gains taxes.
Deploying New Funds
Instead of selling off winners, you can invest additional funds into underperforming assets to bring your portfolio back into balance.
This approach avoids capital gains taxes but may not be feasible for all investors, as it requires an influx of new savings.
FAQs – How Often Should You Rebalance a Portfolio?
How do I determine my desired asset allocation?
Your desired asset allocation should be based on your investment goals, risk tolerance, and investment time horizon.
These factors will depend on your age, income, financial obligations, and retirement plans.
It’s generally a good idea to consult with a financial advisor to help you determine an appropriate asset allocation that aligns with your specific circumstances.
How do I monitor my portfolio for rebalancing opportunities?
Regularly review your portfolio and compare your current allocation with your desired allocation.
You can use portfolio management tools or work with a financial advisor to monitor how your investments are performing.
You can set up a schedule, such as every 3-6 months, to check whether your portfolio needs rebalancing.
Can I rebalance my portfolio too often?
Yes, rebalancing too frequently can lead to increased transaction costs and tax implications, which could negatively impact your overall returns.
It’s important to strike a balance between maintaining your desired allocation and minimizing costs associated with rebalancing.
Some may prefer not to sell “winners” within one year because of capital gains considerations.
What if I don’t have additional funds to deploy for rebalancing?
If you don’t have extra funds to invest, you can still rebalance your portfolio by selling off assets that have appreciated in value and using the proceeds to buy underperforming assets.
Keep in mind that this approach may trigger capital gains taxes, so it’s essential to consider the tax implications before making any transactions.
How can I minimize the tax impact of rebalancing?
To minimize the tax impact of rebalancing, consider utilizing tax-advantaged accounts, such as IRAs or 401(k)s, and employing tax loss harvesting strategies to offset any capital gains.
Additionally, be mindful of the holding period for each asset to qualify for long-term capital gains tax rates, which are generally lower than short-term rates.
Should I rebalance my portfolio during periods of market volatility?
Rebalancing during periods of market volatility can help you capitalize on opportunities and maintain your desired risk level.
However, it’s important to avoid making impulsive decisions based on short-term market fluctuations.
Stick to your predetermined rebalancing strategy and focus on your long-term investment goals.
Can I automate the rebalancing process?
Yes, many robo-advisors and investment platforms offer automated rebalancing features that adjust your portfolio according to your desired allocation and chosen rebalancing strategy.
These services can help simplify the rebalancing process and ensure that your portfolio remains aligned with your investment goals.
However, it’s still a good idea to periodically review your investments and ensure that your chosen strategy aligns with your evolving financial needs.
Conclusion
Rebalancing is an essential aspect of long-term investing, helping you to maintain the desired balance between expected returns and risk.
The ideal frequency of rebalancing depends on your specific circumstances and preferences, with a focus on balancing returns, risk, and costs.
Keep tax considerations in mind and choose a rebalancing method that best suits your needs to ensure your portfolio remains aligned with your investment goals.