Factors that may influence how and when you rebalance

When deciding how often to rebalance your portfolio, you’ll need to consider several factors, including:

• The kinds of assets you hold
• The cost of trading such assets
• Tax issues
• The free time you have available
• Your personal judgement
• How often you can be bothered to do it

I’m serious about that last point, incidentally.

If you’re a very keen investor, you might want to rebalance (subject to costs) every three months or so. Some big institutional funds rebalance every day!

It may seem far too hands-on to churn away your portfolio like this, but if you’re an active investor such rebalancing might stop you doing riskier but tempting things like investing in small caps. (It doesn’t stop me, admittedly!)

Rebalancing is done according to asset allocation, not by backing hunches and so on, so there’s fewer of the common psychological dangers from frequent trading. That said, costs can quickly mount, especially as a proportion of smaller portfolios, as discussed below.

If you’re not that keen on managing your investments, rebalancing will feel like just another chore. You might be best rebalancing every year, or even every few years, rather than creating a plan you’ll never stick to.

There are no rules because asset price moves carry on for unpredictable amounts of time, even if they do tend to return to the mean over the long term.

Personally, I favour longer periods of at least a year or so between rebalancing. This allows assets, especially equities, to enjoy a good spell of outperformance. It also reduces costs. Even every two to five years might be okay.

But remember I have a large tolerance for volatility and am happy to endure fluctuations in my net wealth in pursuit of higher returns.

If your more risk averse, consider rebalancing more often – maybe every six months, but certainly every year.

No rules, no perfect outcomes

Another thing – there’s no point letting hindsight into your rebalancing.

The aim is to create a portfolio which maximizes your gains while trying to diminish volatility to a level you’re happy with. The aim is not to become a market timing hedge fund manager.

All assets move too unpredictably to discount the role of luck in the outcome of your rebalancing over the short to medium term.

• If you only rebalance every three years and those three years happen to span a bull market, you’ll probably tell everyone that infrequent rebalancing is best.

• If you rebalance every three months and it saves you from the worst of a stock market crash, you’ll say frequent rebalancing is best.

All assets (bar cash) can fluctuate a lot over time

Finally, equities aren’t the only assets that move a lot over time.

For example, government bonds like U.S. Treasuries and UK Gilts could be thought of as being in a long bull market since the early 1980s. An asset class that once boasted a yield of 10% now pays about 4% – a huge move for a safe, low volatility investment.

Similar examples of strong price moves over different periods of time could be shown with property prices, commercial bonds and precious metals such as gold.

So I say it again: Don’t kid yourself. Your portfolio rebalancing is going to have an element of hit-and-miss luck about it.

Complicated rebalancing systems are often derived from back-testing data and could lure you into thinking markets are more predictable than they really are.

Alternatively, such systems may require detailed calculations of rebalancing costs versus expected rewards that in theory boost your returns, but in reality spoil your weekends.

Have a simple plan and stick to it.

And crucially, if you decide you want to change your rebalancing plan, do so in the cold light of day, not because you’ve been sucked into a bull market!

I’ll look more closely at some of the factors above in future episodes of this series on rebalancing, so please do subscribe to stay in the loop.