Module II·Article IV·~2 min read
The Rebalancing Process
Asset Allocation and Multi-Asset Strategies
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The Rebalancing Process
Rebalancing: Portfolio Discipline
Rebalancing is the process of bringing asset weights back to the target values defined in the SAA (Strategic Asset Allocation). This is not just a technical operation—it is the foundation of investment discipline, which forces you to "sell high and buy low".
Why is rebalancing necessary?
- Risk control — Without rebalancing, after growth, stocks will occupy 80% of the portfolio
- Discipline — A mechanical rule against emotions
- Mean Reversion — Historically, overvalued assets revert to the mean
- Alignment with IPS — Maintaining a consistent risk profile
What happens without rebalancing?
Example: 60/40 portfolio from 2010 to 2020:
| Year | Stocks | Bonds | Actual Allocation |
|---|---|---|---|
| 2010 (start) | $600,000 | $400,000 | 60/40 |
| 2015 | $900,000 | $450,000 | 67/33 |
| 2020 | $1,500,000 | $500,000 | 75/25 |
Portfolio risk increased by 50%!
The investor does not realize that their risk tolerance was violated.
Rebalancing Methods
| Method | Description | Pros | Cons |
|---|---|---|---|
| Calendar-Based | Fixed dates (quarterly, annually) | Simplicity, predictability | May miss large deviations |
| Threshold-Based | When deviating by ±3-5% from target weight | Responds to real changes | More transactions |
| Hybrid | Calendar + checking thresholds | Balance | More complex |
| Via Flows | New contributions/dividends directed to underweight classes | Minimum transactions | Slow for large deviations |
Example of Threshold-Based Rebalancing
| Class | Target Weight | Range | Current Weight | Action |
|---|---|---|---|---|
| DM Stocks | 35% | 30-40% | 42% | Sell 7% |
| EM Stocks | 10% | 5-15% | 8% | Normal |
| IG Bonds | 30% | 25-35% | 26% | Buy 4% |
| Cash | 5% | 0-10% | 4% | Normal |
Rebalancing Costs
- Transactional — broker commissions, spreads
- Tax — realization of capital gains
- Market impact — for large portfolios
- Opportunity cost — selling a growing asset
Minimizing Costs
- Rebalancing via flows — new money into underweight classes
- Tax-loss harvesting — using losses to offset gains
- Trading inside tax-advantaged accounts — IRA, retirement accounts
- Wide ranges — fewer transactions
- ETFs instead of individual stocks — simpler and cheaper
Research: The Impact of Rebalancing
Vanguard study (1926-2014):
| Strategy | Annual Return | Volatility |
|---|---|---|
| 60/40 without rebalancing | 8.9% | 14.2% |
| 60/40 annual rebalancing | 8.7% | 10.8% |
| 60/40 threshold (5%) rebalancing | 8.8% | 10.5% |
Conclusion:
Rebalancing slightly reduces returns, but significantly decreases risk.
Automation of Rebalancing
Modern solutions:
- Robo-advisors — automatic rebalancing (Betterment, Wealthfront)
- Target-date funds — auto-rebalancing + glide path
- Portfolio management software — for institutions
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