How often should we rebalance our portfolios?

Photo: Alberto 1412. Source: Wikimedia

Many people have balanced portfolios. And it’s a good idea to divide our assets between stocks, bonds, real estate, and cash. You never know what’s coming up next. But when one asset grows or shrinks a lot compared with the others, our portfolios can begin to look out of balance. When should we even things up?

Rebalancing a portfolio is generally a good move. It forces us to sell assets that have gone up and buy those that haven’t done as well. But asset classes, like companies, do poorly for a reason. In August of 1979 BusinessWeek published a cover story on the death of equities. The stock market had been in a 17-year funk. Double-digit inflation, energy shortages, productivity problems, and scandals were rampant. They described the bear market as a “near permanent condition,” just as stock prices were about to multiply by over 10 times in the next 20 years – the greatest bull market in history.

Source: T3live, PFS Group

BusinessWeek didn’t publish their story to look foolish; they were describing the current sentiment and conditions. Folks who rebalanced their portfolios before that bull run did well. But if they rebalanced too early – during the ‘70s – they had to suffer through some dismal returns to get to the good times.

Rebalancing typically means catching a falling knife, and it can be painful. If you rebalanced in 2000 and 2007, you felt like a genius. But if you sold bonds at the end of 2010 or ’13 or ‘15 because yields “just couldn’t go lower,” you didn’t feel so smart. Rebalancing works, but it can take a while to work.

And frequency is important. If we rebalance too often, we’re just adding trading costs, not value. If we wait too long, we miss out on some of the best opportunities. Many people rebalance annually, around year-end. But that’s not all that rational. There’s nothing magic about December 31st or January 1st. They’re days like any other, and analytic software or robo-advisors that recommend rebalancing around year-end do so because they have year-end performance numbers to calibrate their models.

It makes much more sense to use the actual performance of the markets to determine when to buy and sell. Targets should be set strategically, based on what kind of investor you are. But rebalancing is also a tactical decision, based on market conditions. Research shows that when the market has moved a portfolio 5-10% away from its strategic objective, it’s often a good time to adjust. This allows time for a trend to develop, but also lets us benefit when trend reverses. If we let our portfolios get too far out of whack, we get worried and obsess about them. Our asset allocation is the last thing that should keep us up at night.

Dynamic balance. Public Domain. Source: Wikimedia

Markets move on their own schedules. By waiting until our portfolios show that they need to be adjusted we avoid excessive activity. Patience is often the intelligent investor’s best performing asset.

Douglas R. Tengdin, CFA