“Rebalancing ensures that you buy low and sell high.  It can work. But that doesn’t mean it always works.” 

Jason Zweig, The Wall Street Journal, “Rebalancing Your Portfolio Can Be a Tough Ride”, March 7, 2009

I guess the rebalancing debate will never be settled.

Should you rebalance?  And if so, when is the best time to rebalance?  Does it increase the portfolio’s return? Does it diminish returns in the portfolio?  Is it a form of market timing? 

For the record, The AdvisorBlogger is an ardent structured, passive asset allocation believer.  Yes, I have drank the koolaid of John Bogle, Larry Swedroe, Burton Malkiel, Rex Sinquefeld, Dr. William Bernstein, just to ‘name drop’ a few. 

But what about rebalancing? There is so much written regarding rebalancing; it is enough to make your head spin:

• If you don’t rebalance periodically (once a year, for example) your portfolio will become overly concentrated in the asset classes with the best recent performances. (Dr. Ron Ross, Author, The Unbeatable Market) note from advisorblogger—this is a great book by the way

• However, portfolio rebalancing is not without risks. It relies on the assumption that different classes of assets trend upwards together in the long run: while in the short run different asset classes may diverge from their long-term growth rates, reversion to the mean ensures that ultimately they should return to their long-term trajectory.  But is this assumption correct? It may be true of US stocks, bonds and real estate. (Though only a couple of years ago many people claimed that stocks appreciated more over the long term than other asset classes.) But it hasn’t been true for a while of gold or of Japanese stocks. If asset classes do not trend upwards together in the long run, then rebalancing pushes an investor to move funds from asset classes that appreciate to asset classes that go nowhere or depreciate. (David Jackson, Author, Seeking Alpha)

• After establishing asset allocation policies, risk control requires regular rebalancing to policy targets.  Movements in prices of financial assets inevitably cause asset allocations to deviate from target levels. (David Swensen, Author, Yale, CIO, Pioneering Portfolio Management)

• Rebalancing provides investors with practice for resisting temptation to second-guess their strategy during inevitable difficult periods. (Larry Swedroe, Author, The Only Guide to a Winning Investment Strategy You’ll Ever Need)  advisorblogger says that this is a must read and should be in any advisors library

• Rebalancing is a personal choice, not a choice that statistics can validate. There’s certainly nothing the matter with doing it (although I don’t do it myself), but also no reason to slavishly worry about small changes in the equity ratio. Maybe, for example, if your 50% equity position grew to, say, 55% or 60%.  In candor, I should add that I see no circumstance under which rebalancing through an adviser charging 1% could possibly add value. (John Bogle, The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns)

So what are we to make of all this stuff? 

First I think advisors should be careful not to assume and say that rebalancing is a ‘guarantee’ for higher returns. I am reminded of what Geoff Considine, President of Quantext says, “There are a number of concepts in investing that are treated as though they are as well thought out as gravity—simple, inexorable, and undeniable”.  I think rebalancing falls into this camp.

Secondly, the intent of rebalancing is to get the portfolio back to its original asset allocation targets (assuming that you believe that diversification is your goal).

Lastly, I agree with the conclusion of Jason Zweig: 

“For younger investors with horizons of several decades, rebalancing is probably a chance worth taking. But you shouldn't feel compelled to rebalance constantly; once a year is plenty. Pick a date that will never vary and that you will always remember, like your birthday. If you are retired, rebalancing into stocks could hurt more than it may help; catching a butcher-block full of falling knives is a risk you mightn't be able to afford to take. I will still rebalance on my next birthday, because I am nowhere near retirement and I know I don't know what the future holds.

The bottom line: Whether rebalancing will heal or hurt your portfolio depends not only on what the markets do but also how they do it. Even techniques that are supposed to reduce risk carry risks of their own.”

In closing, the AdvisorBlogger created slides (located under the links) from the rebalancing study in Jason Zweig’s “Rebalancing Your Portfolio Can Be a Tough Ride” article.  They can be downloaded and viewed by clicking REBALANCING.  

On another note regarding Mr. Bogle's comments regarding rebalancing and an advisor's fee of 1%...the reality is that there are FEW investors that can remain disciplined with their allocation targets when the markets become volatile.  Most investors let their emotions get the best of them and without the thoughtful guidance of a trusted advisor, the investor will notoriously sell when prices are low or get back in when  prices are high.  The Dalbar Study is evident that investors really are their own worst enemy.  An advisor who can keep their clients prudent, unemotional, and focused to the portfolios intended objective, is a fee worthy advisor.  I just find it hard to believe that investors can actually stay detached and prudent without the guidance and help of an advisor.  

Articles Referenced in This Post:

Extolling the Value of the Long View

Oops, It Maybe Time to Rebalance That Portfolio

Should Portfolio Rebalanced Be Considered Market Timing

Vanguard's John Bogle on Rebalancing-Don't

How to Make Money by Rebalancing

Rethinking Rebalancing

 Rebalancing Your Portfolio Can Be a Tough Ride (slides)

August 1929-January 1945

December 1993-August 2008

September 2007-February 2009

 Jason Zweig on Rebalancing Video