Investment Basics: Rebalancing

When we work with our pilot clients, we follow a disciplined process to make the most of their retirement plan over their lifetime. We follow a number of steps to develop a customized financial plan, and then build a portfolio that we believe will accomplish that plan. One important step in our work with clients takes place after the investments are in place. It is portfolio rebalancing. Here's how it works:

Initially, we set a target asset allocation for your portfolio. As time progresses, the original allocation changes because investments in the portfolio rise and fall at different rates. So, on a regular basis, we bring the investments back into alignment when they deviate too far from their long term targets.

You could liken rebalancing to the slight adjustments you make to your plane to keep it on course. Markets move up and down in the same way that winds and air pressure may take you off the course to your target destination. Think of rebalancing as getting you back on your flight plan.

Rebalancing is also a disciplined way to “buy low and sell high.” Why? When we realign your asset allocation, we trim investments in areas that have performed relatively well and reallocate those assets to areas that may be undervalued and present opportunities for good performance. Over time, studies have shown that rebalancing portfolios on a regular basis can add value.

One such study was conducted by Burton Malkiel. Malkiel looked at returns of portfolios over a period of 15 years and found that rebalancing had the potential to increase investor returns by an average of approximately 1.5% per year.

How often should you rebalance your portfolio? The answer partially lies in how your portfolio is constructed; however, we believe that most portfolios should be rebalanced on an annual basis, or after significant moves in the market. We avoid rebalancing portfolios more frequently because we want to limit transaction costs and also want to capture the short term benefit of “letting winners run.”

We also utilize a “tactical overlay” strategy, which acts as a complement to the systematic approach of rebalancing. Our tactical overlay strategy seeks to make minor, short term adjustments to a client's strategic asset allocation based on where we believe there is value in the market. The overlay allows us to look across asset classes and sub‐asset classes to determine what appears to be “expensive or cheap,” and adjust portfolios accordingly.

With busy lives, remembering to rebalance is often the challenge. That is one of many reasons why we regularly review client portfolios. We know from experience that this part of our overall process can add real value over time.