1. Portfolio Rebalancing in Theory and Practice by Vanguard Institutional Research
To ensure that a portfolio?s risk and return characteristics remain consistent over time, a portfolio must be rebalanced. The appropriate rebalancing strategy depends on a number of factors such as the market environment and asset-class characteristics. Rebalancing achieves the goal of risk control relative to the target asset allocation in all market environments. Although market return patterns may create opportunities for tactical rebalancing, this active strategy is challenging. Based on reasonable expectations about return patterns, average returns, risk, and correlations, we conclude that for most broadly diversified stock and bond fund portfolios, annual or semiannual monitoring, with rebalancing at 5% thresholds, produces an acceptable balance between risk control and cost minimization. To the extent possible, this rebalancing strategy should be carried out by appropriately redirecting interest income, dividends, new contributions, and withdrawals.
2. Opportunistic Rebalancing: A New Paradigm for Wealth Managers by by Gobind Daryanani CFP®, Ph.D, FPA Journal (January, 2008)
* Wealth managers traditionally rebalance portfolios quarterly or annually to control risk due to asset class drifts. This paper proposes a new paradigm for planners: rebalance less frequently, but look more frequently to find the best opportunities for rebalancing.
* The proposed approach, called opportunistic rebalancing, not only controls portfolio drift, but also provides significant return improvements by capturing buy-low/sell-high opportunities as asset classes sporadically drift relative to each other.
* The paper studies a wide range of market conditions to show that rebalancing return benefits can be more than doubled compared with the traditional annual rebalancing.
* These additional benefits, attributed to transient momentum and mean reversion effects, occur sporadically in time and can only be captured by monitoring portfolios frequently.
* The studies suggest these practical guidelines: (1) use wider rebalance bands, (2) evaluate client portfolios biweekly, (3) only rebalance asset classes that are out of balance—not classes that are in balance, and (4) increase the number of uncorrelated classes used in portfolios.
* The studies show that trading costs and tax deferral are small compared with rebalance benefits.
* Opportunistic rebalancing has already been adopted by a number of leading wealth management firms across the country.
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