posted on November 17th 2015 in Your Financial Advisor with 0 Comments /

Morgan Smith was recently interviewed to discuss the importance of rebalancing and provided tips to investors to make the practice easier. Below is the full Q&A with insightful tips to take away…


In your opinion, why do so many people fail to rebalance? What do you tell your clients when trying to convince them of the value of rebalancing?

There are generally going to be two types of investors: those that pay very close attention to their investments: “The Attentives,” and those that are just too busy with their lives: “Everyone Else.”

The Attentive: Most attentive investors fail to rebalance because they get analysis paralysis. There are numerous rebalancing strategies that have been proposed and the attentive investor tends to be the analytic. Unfortunately, rebalancing is as much of an art as it is a science and there is no fits-all clear-cut methodology for rebalancing. This tends to stop the analytic in their tracks.

Everyone Else: Everyone else is generally too busy. They lack the time and resources to not only make informed decisions, but to implement them as well. . There are very many variables in the rebalancing decision making process and it can get overwhelming. Very importantly, they are most likely unclear as to what the baseline should be for their asset classes.

Both of these investors would benefit with first having an Investment Policy Statement (IPS). An IPS will clearly define the baseline for their portfolio risk characteristics and cover rebalancing guidelines. You really can’t rebalance unless you have targets to rebalance to. These factors all highlight the benefit of professionally managed portfolios with clearly defined goals.

For retirement plan participants, I’ve found that although having a long list of investment choices sounds good, it is most likely hurting them as it opens up more opportunities for bad decisions and increases the complexity of the rebalancing process.

How often do you recommend that investors rebalance their portfolios? Why do you suggest this time frame?

You often see recommendations to balance monthly, quarterly, annually, etc. This as a recommendation based on an arbitrary time frame and really has limited value in the real world.

A good analogy would be to ask yourself when would you use your windshield wipers on your car. Would you turn them on monthly, quarterly, annually? No, that makes no sense at all. Turning them on when the sun is out and you don’t need them wastes energy, time, and really does not help you. You turn your wipers on when conditions arise such that the wiper blades will help, for example, when it’s raining and you are driving.

Similarly with investment portfolios, you should only think about rebalancing when market conditions arise such that rebalancing helps. In this case, helping means getting you back to the risk targets of your personal IPS. So, when there are significant movements in any asset class that you hold, you would ideally want to look at rebalancing opportunities. As such, your timeframe should be market-driven as opposed to relying on arbitrary time frames.

The caveat to this rule of thumb is that every time you invest new cash into your portfolio, this becomes an efficient opportunity to rebalance. It becomes efficient in that you can usually eliminate the sell transaction(s) and instead rebalance by buying into asset classes that are down in value.

Are there any potential disadvantages to rebalancing?

Yes, there are several:

  1. Cost vs. Value: There are many great investment ideas put forward by the media, investment gurus, relatives and friends. The problem with most of these ideas is that the actual cost of implementing the idea often exceeds the value of the proposed strategy and rebalancing is not immune to this phenomenon. With rebalancing, you generally have trading costs, administrative costs, and for taxable accounts, capital gains costs. So, beware of the rebalancing strategy that does not take these costs into consideration as they could do you more harm than the actual rebalancing strategy was designed to deliver.
  2. Great Study — Limited Usefulness: Many rebalancing studies rely on data from shorter time frames and thus the results of the published benefits are ambiguous. For example, many rebalancing studies rely on data from ten to twenty year periods when it takes over twenty years of data just to distinguish the premium of stocks from zero. So, beware the conclusion of studies based on shorter time periods. Foundations of intelligent investing really takes decades to play out and you may not see any benefit at all from rebalancing over shorter time frames.
  3. Focusing On Return Instead of Risk: Rebalancing is really about maintaining the risk characteristics of your portfolio as opposed to trying to adjust your portfolio by way of predicting where you think returns will come from. Investors should not magically expect immediate improvements on portfolio returns after rebalancing as no one can predict when and where their returns will happen. It’s the structure of your portfolio that is all important and that should be where the focus lies.

Many people have funds with different providers – a little at Fidelity, some at Vanguard, or in a separate 401K – and may find it difficult to do the math across all of these providers to properly rebalance.  What tips can you offer them?

This is a very common occurrence, not only with investors doing things on their own but advisors who have clients with accounts at multiple custodians. Usually the left hand is not talking to the right hand and you end up with uncoordinated strategies which can lead to terrible results.

The best tip I can offer them is to find an advisor who has the technology to consolidate all the information from their different accounts into one view.

WorthPointe 360 uses a system that does this, regardless of where their accounts are custodied. This allows for analysis of portfolios across accounts and collaboration with clients. When you are able to do this, you can then truly construct a unified “household” strategy.

Contact us
if you’d like to discuss rebalancing and the future of your financial plan.

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