Portfolio Rebalancing: Observations From 25 Years of Data

by Charles Rotblut, CFA

I now have 25 years of data on rebalancing.

Using Vanguard mutual funds that are available to all individual investors, I have tracked the performance of hypothetical portfolios following AAII’s moderate asset allocation model that could have easily been replicated by individual investors. The results show that rebalancing lowered the level of volatility. At the same time, the risk-reduction strategy enhanced returns, which is a reflection of the last two bear markets and the positive role rebalancing played.

In this article, I review the updated numbers. (No rebalancing was required at the end of 2012.) I also point out an important consideration for retirees holding one fund with comparatively lower long-term rates of return relative to the other funds in their portfolio. Finally, I discuss alternatives and options as well as explain how to rebalance within a specific asset class, such as stocks.

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Charles Rotblut is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.
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As you review the data and my observations, I want you to look at rebalancing from the context of behavioral finance. Rebalancing is a strategy designed to maintain your long-term portfolio allocations. Unlike strategies designed to maximize your performance, rebalancing strikes a balance between risk and return. Its success comes from both alerting you to buy low and sell high and giving you a strategy for coping with whatever the market throws at you.

A Primer on Rebalancing

As some of you may recall from my article last year, “Portfolio Rebalancing: Diversification, Risk Control and Withdrawals” (March 2012 AAII Journal), rebalancing is the process of shifting your portfolio dollars out of asset classes that are overweighted and into asset classes that are underweighted, according to your personal goals and tolerance for risk. It is a strategy that complements diversification by ensuring that your portfolio does not stray too far from your allocation targets.

Here is a simple example I like to use when discussing rebalancing. Let’s say a portfolio is evenly split between large-cap stocks and long-term Treasury bonds (a 50% allocation to each asset class). After one year, volatile market conditions send stock prices lower and bond prices higher. As a result, the portfolio’s allocation shifts from 50% stocks and 50% bonds to 44% stocks and 56% bonds. Rebalancing would move 6% of the portfolio’s dollars out of bonds (lowering the allocation from 56% to 50%) and into stocks (raising the allocation from 44% to 50%), returning the portfolio to its target allocations.

This process preserves the benefits of diversification, as long-term data from the Ibbotson SBBI Classic Yearbook (Morningstar, 2012) demonstrates. A portfolio that started with the simple allocation of 50% large-cap stocks and 50% long-term government bonds that was never rebalanced eventually evolved into nearly an all-stock portfolio. Over the period of 1926 to 2011, the allocation for such a portfolio evolved to 96.3% stocks and 3.7% bonds. Worse yet, the portfolio became nearly 40% more volatile than it would have been if it had been rebalanced on an annual basis.

Even though the study was conducted over a very long period (1926 to 2011), the lesson is clear: The benefits of diversification will be limited if an investor does not rebalance on a regular basis. Rather, risk will increase, even though a big reason for diversifying is to reduce risk. To put things bluntly, if you think diversification is important, you should also think rebalancing is important. Without periodic rebalancing, diversification fails.

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Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/CharlesRAAII.


Janette Andrews from MI posted over 2 years ago:

Thanks for the portfolio allocation suggestions. Gotta start there before figuring out the rebalancing.

H Mercer from TX posted over 2 years ago:

Yes, yes, yes. And to think if you had been so dumb as to put your entire $100K in the S&P 500 (VFINX), your final result would be ................lets see 5 times $196846 , that would come to $984230 and you could have slept through the whole 25 years. Much less "fun" however.

C Robinson from VA posted over 2 years ago:

I expect the following has already been spotted, but in case it has not: Table 4 has errors in 1995 and 1996; do not add to 100%. Table 3 implies the error is not accounting for VTRIX at time of rebalance.

Mark Henwood from CA posted over 2 years ago:

If the portfolio is taxable what effect does reblancing have?

Chris Carter from CA posted over 2 years ago:

Nice little summary reconfirming one of the most basic, fundamental concepts of portfolio management.

Personally, rather than beat the above "dead horse", I would have liked to see him explore the effects of different rebalance strategies (for ex., "oportunistic rebalancing") and rebalancing effects on non-qualified accounts.

Edward Curtis from FL posted over 2 years ago:

I would like to see the results at higher withdrawal rates. I suspect that the results would be much more dramatic.

Charles Rotblut from IL posted over 2 years ago:

Thanks for the comments. A few responses.

H Mercer - $100k in the VFINX would have increased to $984,229 versus $907,694 for the rebalanced, non-withdrawal portfolio. But, you would have had more volatility, so there was a trade-off.

C Robinson - Two cells with the allocation percentages were accidentally not copied over to Table 4. We've corrected the mistake.

Mark - You will incur taxes when you transact in a taxable account. The 5%, or even a 10%, range will reduce the number of transactions. You can also use your IRAs to help reduce the brunt of the tax implications of rebalancing. But, if you don't rebalance because of tax reasons, you have to be sure that you can withstand the volatility of the markets.

Edward - I'm using the data for May article on the mechanics of making retirement withdrawals from a fund portfolio. The article adjusts the 4% rate for inflation and discusses the implications of using a higher withdrawal rate. I need to rerun the numbers before saying anything about them, but I think you will find it to be of interest.


R Curry from CA posted over 2 years ago:

I thought the 4% rule of thumb applied to the initial portfolio balance. From then on, it is that dollar amount adjusted for inflation, not 4% of the year-end balance.

If a portfolio's initial balance is $100,000, the first withdrawal is $4,000. From then on the withdrawals are $4,000 adjusted for inflation.

Victor Shames from CA posted over 2 years ago:

I found this article most interesting. Please give me an example of how you made the calculation of year end value of a fund. For example how does VFINX go from $70811 to $78385 between 2011 and 2012.

Charles Rotblut from IL posted over 2 years ago:

Hi Victor,

VFINX realized a 15.82% return in 2012, so for the non-rebalanced version of the 4% withdrawal portfolio, the math is the fund's gain less the annual withdrawal.


Herb Kuntz from California posted over 2 years ago:

I read several of the articles in the Journal & the above comments on re-balancing. I find the tax implications to be most meaningful. Tables 2 & 3 do not account for taxes on re-balancing. In CA, in the low tax bracket ~25% of any gain is lost to taxes & in the highest bracket it may be as much as 35% (who knows what it really might be...). That gives an edge to the no re-balance portfolio. In addition, one could re-balance by taking $ only out of the highest gainers, resolving the international fund depletion.

adam from MASS posted over 2 years ago:

It would be useful to have an article written about using basic technical indicators to refine decisions about when to perform rebalancing. We are in an era when moving averages, bollinger band graphing and other technical manipulations are readily available on-line (I use Yahoo finance for this.) While no one can perfectly time the market, some consideration of techical indicators may enhance return by possibly keeping wining investments longer, and delaying purchase of underperforming assets closer to their nadir. Thanks

Kim from Pennsylvania posted over 2 years ago:

Awesome data. I printed it out to assist me in staying on target. This will be filed under investment ideas, which I read through periodically to help me stay the course.

Jane G from California. posted over 2 years ago:

70% equity allocation seems aggressive for retirees, not moderate. I would like to see the numbers for a 30%,
40%, and 50% equity allocation and see if the 4% rule still holds.

Kelvin from Alberta posted over 2 years ago:

Extending what R.Curry posted above, and in consideration of the subsequent article in the May issue, "Taking Retirement Withdrawals from a Fund Portfolio", I see there has are two variations of the withdrawal method presented but not discussed.

In the April issue, the 4% withdrawal was taken simply as 4% of the year-end portfolio balance.
- Total Withdrawals: $242,642
- End Portfolio Value: $329,165*

In the May issue, the same portfolio was presented but using withdrawals based on an initial 4% adjusted for inflation.
- Total Withdrawals: $305,304
- End Portfolio Value: $203,767*

A conventional "4% adjusted for inflation" would start with 4% ($4,000 in 1988) and then adjust the actual withdrawal (not the percentage) by inflation over time.

How would this portfolio ($100k, Rebalanced, Non Pro Rata) perform over the same time frame in comparison to the other two I wonder?

As a final check-point, I calculate the total COLA adjustment for the period 1988 to 2013 to be 2.0416. This implies that the original $100k portfolio (1988) has a current value of approx. $204k. This number is similar to the May issue final value (also $204k) implying that the hypothetical retiree was able to live for 25 years on his savings without diminishing the value of his portfolio. Not to mention that the 4% rate was, in fact, survivable!

Charles Rotblut from IL posted over 2 years ago:


You will find updated numbers in this addendum:


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