Rebalancing is the process of making periodic adjustments to an investment portfolio to help ensure the asset allocation remains consistent with the investor’s long-term investment strategy. The objective of this article is to provide information on some of the most popular portfolio rebalancing strategies and help you understand how important periodic rebalancing can be to your long-term investment success.
Choice of Strategies when Rebalancing:
Periodic Rebalancing. Periodic Rebalancing requires a portfolio to be reset to its target allocations on a fixed schedule – such as monthly, quarterly, or annually. This strategy has the virtue of simplicity, but can require frequent, minor adjustments. It can also be very rigid, and doesn’t allow investors to temporarily overweight asset classes or sectors that are expected to outperform over the shorter term.
Threshold Rebalancing. This strategy requires portfolios to be adjusted if and when a particular asset class deviates from its target allocation by more than a certain amount – such as a specific percentage point. This strategy is more flexible than periodic rebalancing, but in volatile markets it can trigger a great deal of unnecessary buying and selling.
Range Rebalancing. This approach is similar to threshold rebalancing, except that when an asset class rises or falls more than the allowed amount, it is rebalanced back to the maximum, not the target, allocation. When using range rebalancing, investors adjust their portfolios to a maximum deviation amount when they rise or fall more than the allowed amount.
Volatility-based Rebalancing. This method is based on the expected volatility of the portfolio as a whole. When portfolio volatility rises above a certain predetermined threshold, higher-volatility asset classes are sold and lower-volatility asset classes are purchased until the desired risk characteristics have been restored.
Active Rebalancing. This process entails the rebalancing of the portfolio to target allocations based on an analysis of expected market conditions. This approach is similar to “tactical” asset allocation, which seeks to exploit short-term market trends. However, it is more conservative than a pure market-timing approach, because changes in the portfolio tend to be relatively modest.
When considering rebalancing, it is important to understand the pros and cons of each method. There may be monetary costs to rebalancing, such as commissions and tax expenses. If portfolio corrections are made frequently, these costs may increase as well.
The primary goal of rebalancing is make sure your portfolio remains consistent with your long-term investment strategy. In periods of market volatility – including periods of out performance by a particular asset class – rebalancing can play a critical role in limiting your exposure to risk.
If you would like to meet with a Peak Financial Partners adviser to develop a financial plan for your family, please call us at 1-614-542-7242; or send an email toinfo@peakfinancialpartners.com.