Best Practices for Portfolio Rebalancing
The primary goal of a rebalancing strategy is to minimize risk relative to a target asset allocation, rather than to maximize returns.
It is well documented that a portfolio’s asset allocation is the major determinant of a portfolio’s risk-and-return characteristics (assuming a well-diversified portfolio that engages in limited market timing). Yet, over time, asset classes produce different returns, so the portfolio’s asset allocation will likely drift. Therefore, to recapture the portfolio’s original risk-and-return characteristics, the portfolio should be rebalanced.
Many investors ask “how often, how far and how much” to rebalance a portfolio. Similar to the initial selection of a portfolio’s target asset allocation, the selection of a rebalancing strategy involves a trade-off between risk and return. In theory, investors should choose a rebalancing strategy that weighs their willingness to assume risk against expected returns net of the costs of rebalancing—including time, taxes and labor.
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Colleen M. Jaconetti is an senior investment analyst in the Vanguard Investment Strategy Group.
Yan Zilbering is an investment analyst in the Vanguard Investment Strategy Group.