Simple Portfolio Rebalancing: Year-End vs. Random Day

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I’m catching up on some reading. James Picerno of The Capital Spectator did some backtesting of simple portfolio rebalancing where once a year you go back to your target asset allocation. Does it matter if you rebalance at the end of every year, or just pick any random date once a year? His test portfolio was a globally diversified portfolio made up 60% stocks and 40% bonds (11 different funds).

Here’s a chart of his results:


His comments:

The basic message: rebalancing is a valuable tool for generating superior risk-adjusted performance. But it seems that tapping into this value-added service doesn’t require a lot of intellectual firepower for a standard asset allocation strategy. Letting a monkey choose the rebalancing dates over a period of years works as well if not better than automatically rebalancing at the end of each year.

My version: Rebalancing helps you maintain your desired risk profile, and it may even improve your risk-adjusted returns (it did in the last decade). Get the benefit with minimal fuss by rebalancing once a year. It doesn’t really matter what day, just make sure to do it once a year. However, I find it easier to stick with the same one every year so you can put it on your calendar. (First business day after Christmas, July 1st, your birthday, etc.)

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  1. Load-balancing should be an easy concept to grasp but I still have some difficulties understanding why load-balancing (say) every week would not be giving you best results (assuming there are no transaction costs doing so). Isn’t load balancing the equivalent of selling high – buying low? Why you wouldn’t want to sell high and buy low more than once a year?

    Most of my money (outside 401k) is invested in a robot-advisor (Betterment) and I know that any new money (new deposits + dividends) is investing in the funds that became underweight and that just makes sense to me to do that EVERY time you have new money. They will also rebalance if your portfolio drifts too much but that doesn’t seem to happen a lot…and that would involve selling some funds that did well, creating taxable gains. Ok, so frequent rebalancing in a taxable account could create a nightmare a tax time but I’m not sure if that would negate the effects of selling high, buying low.

    • I haven’t heard of load balancing (in the financial portfolio sense) before. Do you mean that each new contribution will be allocated across funds in the best way to bring your overall allocation back into balance? So, for example, if international funds are down sharply but domestic has been flat, all of a contribution might go into the international fund? If so, that sounds useful. I doubt Fidelity offers such an option, unfortunately.

  2. Gene McPhail says

    The rebalance every week could result in churn and possible extra fees.
    I vote for May (sell equities in May) and Oct (buy equities in Oct) or watch for opportunities (buy low and sell high).
    January historically has more than average gains so no wonder end-of-year does so poorly.
    New money can be used to help rebalance. Basically equities are more volatile so the reason for rebalance is because stocks have gone up or down .
    Therefore, rebalance activity forces you to buy low and sell high and maintain diversification.

  3. I rebalance two ways:
    (1) I try to send new money each paycheck to the asset class most in need of a boost. I check up on this every month or so. (Been sending everything to International for a while now.)
    (2) I use rebalancing bands rather than annually, which I track on a spreadsheet that automatically updates my balances in each asset class – all I have to keep updated is the number of shares. I set it to highlight the cell in yellow if it is off by more than absolute 5% or 25% of my target allocation (if you’re interested in this, Google “Swedroe 5 25 rule).

    I check in on and update the asset allocation spreadsheet at least a couple times a month, so if an asset class goes outside the bands, I’ll likely catch it and perform the rebalance transactions soon enough. For people who don’t want to check that often, maybe annually as Jonathan suggests is a better idea.

  4. It seems to me that the random day does better simply because you’re not doing it at the same time as the crowd. If everyone does it at the end of the year, that would affect prices.

  5. When I re-balance, I use stochastics and the relative strength indicator as a guidepost to make transactions; in the event that they are near peaks, I don’t move.
    When they are scraping the bottom (when selling pressure is pretty much done) I allocate towards equities, out of the stable value fund.
    I’ve only recently discovered the correlation between peaks and valleys in stock prices and their corresponding peaks and valleys in the stochastics and RSI.
    So far, I’ve bought at or near the trough, and stayed invested while the indicators were near the peaks.

  6. Rebalancing doesn’t produce higher expected returns (in fact it produces lower expected returns). Of course it can produce higher returns in any given period because of randomness. The only point of rebalancing is to reduce risk. So it makes no sense to do a backtest of rebalancing that only looks at return and not risk.

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