After the Allocation: Portfolio Rebalancing 101

According to a Wells Fargo/Gallup survey, over 30% of investors would rather sit in an hour of traffic than rebalance their portfolios. Which, one can deduce, indicates that roughly one third of investors spend at least sixty unpleasant minutes when the time comes to rebalance! In this article, we seek to demystify and simplify the rebalancing process in an effort to save investors time, frustration, and confusion.

Why do we need to rebalance portfolios?

When you first construct a portfolio for your client, the asset allocation of that portfolio is set to meet their investment goals while respecting their tolerance for risk. As time passes and the market fluctuates, the securities within your portfolio earn different returns and change the portfolio weights. While typically these aren’t dramatic weight changes, over time they can result in a portfolio that looks nothing like what you initially set up. For example, let’s say you have a client with a portfolio comprised of 40% stocks and 60% bonds. If those stocks increase in value, the portfolio will become more heavily weighted towards stocks and thus have higher exposure to losses. By rebalancing the portfolio, you can maintain the original asset allocation preferences and reduce risk.

When do we rebalance?

Most investors or investment managers choose to rebalance portfolios annually—which is almost always sufficient! A major advantage of annual rebalancing is that it is less time consuming than other methods, and can also reduce transaction costs and potential taxes. Many investors chose to rebalance towards the end of the year when considering tax-loss harvesting strategies.

Michael Kitces, author of the web resource Nerd’s Eye View, discusses the benefits of rebalancing using thresholds or “allocation tolerance bands.” Rebalancing based on a threshold means that you only rebalance if a particular asset class has crossed the line of how over-or-underweighted it has become. Though this may be more time consuming, it presents the opportunity for greater short term returns. Read more here.

How do we rebalance?

There are two main methods to rebalance a portfolio. Firstly, you can sell investments in an overweight asset class and invest that money in a class that is underweight. Alternatively, you can add or remove money from the portfolio (rather than moving money around within, you could simply withdraw from the overweight class or put new money into the underweight class). Your rebalancing method and frequency may differ based on transaction costs and tax considerations (as mentioned before).

Rebalancing automation tools have been available for almost two decades, but advisors have been slow to welcome this innovation— which is perhaps why many of them would rather sit in traffic than rebalance a portfolio! Those who rebalance using Excel spreadsheets in 2018 are behind the curve, as these tools have become increasingly popular in the last few years and many advisors are realizing great benefits. Rebalancing software saves advisors time, frustration, and headaches by automating trades, making optimization suggestions, and setting alerts for threshold-based strategies.

Things to consider when researching rebalancing tools:

  • Does the software integrate with my other systems?
  • Is the software easy to implement? What is the on-boarding process?
  • Is the software tax efficient?
  • Can it support complex constraints?



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