Date : May 21, 2019
Category : Financial Planning
By Stewart Darrell, CFA
Rebalancing is the process of adjusting a portfolio’s current asset allocation to pre-established target weights, based on a specific investor’s goals and risk appetite. According to a recent Vanguard study, asset allocation contributes to 91.1% of portfolio performance with the balance attributed to security selection.¹ With asset allocation as the primary driver of portfolio return, adhering to an appropriate rebalancing strategy to maintain a designated a long-term strategic asset allocation plays an important role in risk management. Calendar rebalancing and percentage-of-portfolio rebalancing are the two most common rebalancing disciplines:
Calendar rebalancing is a strategy based on time periods, and ensures that a portfolio matches target asset allocation weightings on a monthly, quarterly, semiannual or annual basis. The advantage of calendar rebalancing is that it is straightforward and relatively simple to execute. The primary disadvantage is that the strategy is detached from real-time movements in the markets.
Percentage-of-portfolio rebalancing is unrelated to calendar dates and instead sets rebalancing limits for each asset class. Once an asset class’s weighting falls outside of the pre-determined rebalancing limits, the portfolio is rebalanced back to the target asset allocation. For example, a U.S. stock allocation may have a target allocation of 35% with an upper limit of 40% and a lower limit of 30%. If the U.S. stock allocation exceeds 40% of the total portfolio or falls below 30%, it is rebalanced to the initial 35% target allocation. The advantage of this rebalancing strategy is that it is directly related to market movements. Furthermore, it allows for maximum risk management because rebalancing limits can be set at desired intervals. The primary disadvantage is that percentage-of-portfolio rebalancing requires continual hands-on monitoring.
Other factors to consider in any rebalancing strategy include transactions costs, tax consequences, asset class volatility, correlations between asset classes and overall portfolio volatility. Such factors generally influence rebalancing periods under the calendar method and rebalancing limits under the percentage-of-portfolio method.
When rebalancing client portfolios, Harris Financial Advisors takes a measured approach to the percentage-of-portfolio rebalancing method by incorporating our best judgement, and by focusing on deviations from target asset class weightings caused by real-time market movements rather than arbitrary calendar dates. Setting the appropriate asset allocation and rebalancing limits involves understanding an investor’s ability and willingness to take risk within the context of their overall financial experience. This is why we go to great lengths to establish meaningful relationships with our clients and diligently overlay quantitative data to arrive at the most appropriate asset allocation for each and every one of our clients.
Markets will inevitably fluctuate and it is important to maintain an appropriate asset allocation through an effective rebalancing strategy. If you are already a client, we are actively monitoring your portfolio and adjusting your asset allocation according to the rebalancing limits set forth in your Investment Policy Statement (IPS), real-time market movements and our best judgement. If you are not a client, please contact us to explore how we can help you.
1. Scott, Brian; Balsamo, James; McShane, Kelly; Tasopoulos, Chris. ”The global case for strategic asset allocation and an examination of home bias,” Vanguard Research, February 2017. personal.vanguard.com/pdf/ISGGAA.pdf. PDF download.