How Often Should Investors Rebalance Their Portfolios?
Rebalancing is a crucial practice to maintain your investment assets aligned with your original financial goals and strategy. However, over-rebalancing can lead to over-management, which is counterproductive and might not yield the best results.
Choosing the Right Rebalancing Strategy
The question often arises as to whether you should rebalance your portfolios periodically or only when they shift away from your predefined plans. The key is to find a balance between regular reevaluation and maintaining the status quo when everything is in harmony.
The traditional approach suggests two main strategies: periodic rebalancing or rebalancing only when there is a significant shift in asset allocation. Periodic rebalancing, while systematic, can lead to unnecessary trades and higher transaction costs. On the other hand, rebalancing only when necessary helps to avoid the cognitive bias of managing the portfolio too frequently.
Personal Experiences and Insights
Take, for example, one of my friends who started trading in her 90s and has been successful, making and retaining millions. She spends just a few hours every week reviewing her holdings and selling off those that are performing poorly. Even at 98, she still retains her sharpness and finds the process enjoyable rather than daunting. This underscores the importance of adapting to one's capabilities and not overburdening oneself with too much maintenance work.
Similarly, her approach reflects a fundamental rule in trading: to cut losses short and let profits run. Applying this wisdom to investment is not only prudent but can also help in achieving better returns in the long term. By continuing to invest in strong performers and exiting weak ones, you can optimize your portfolio's performance.
Rebalancing and its Limitations
While many believe that constant rebalancing and adjustment are necessary for good investment, the reality is more nuanced. Frequent rebalancing can often lead to mediocre returns. This is because when you rebalance, you are essentially buying more of the underperforming assets and selling off the ones that are doing well. This strategy is akin to cutting losses and taking profits, but it can result in a shift lower in the overall performance of your portfolio.
Historically, the best investment strategy often favors holding onto positions that are performing well and reallocating only when there is a significant shift in the returns or risk profile. An empirical study, which I found mentioned in various financial literature, supports this view. It highlights that the majority of average investors may not be as skilled as they believe and that frequent rebalancing can add unnecessary complexity and cost.
When to Rebalance?
Deciding when to rebalance can be quite subjective, but the general advice is to do so when your portfolio drifts significantly from your risk-return objective. This means that if your portfolio moves away from your targeted asset allocation by more than a predefined margin, it might be time to reevaluate and make adjustments.
Alternatively, if you find that the effort of constant management is too much, you might want to consider investing in exchange-traded funds (ETFs) or other professionally managed investment vehicles. These options allow you to benefit from the expertise of fund managers without the hassle of frequent adjustment.
In conclusion, the frequency of rebalancing should be tailored to individual needs and risk tolerance. Regular consultation with a financial advisor can provide guidance and ensure that you are on the right track. Whether you choose a periodic or dynamic approach, the aim is to achieve your financial goals without excessive management.