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Portfolio Rebalancing: The Whys and The Hows

Summary

  • Ideally, to eliminate style drift investors should rebalance daily. However, because the real world involves costs, investors should reduce, not eliminate, style drift to an acceptable level.
  • Investors should rebalance wherever there is sufficient cash to make the effort worthwhile, thus eliminating any tax issues and either eliminating or minimizing trading costs.
  • An investor’s investment policy statement (IPS) should include targeted asset allocations as well as minimums and maximums and a rebalancing table.

Rebalancing is the process by which a portfolio’s “style drift” caused by market movements is eliminated or minimized. Style drift causes the risk and expected return of the portfolio to change. Thus, if you want to eliminate style drift, you should rebalance daily. However, in the real world there are often costs (trading expenses and in taxable accounts taxes) including the time and effort to rebalance. Thus, you want to reduce (not eliminate) style drift to an acceptable level. That raises the question of how to determine when you should rebalance.

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