The real value of rebalancing your portfolio

Rebalancing your portfolio is a widely parroted investment basic, but not everyone agrees that it boosts your returns


An annual evening of the scales is good discipline

One under-appreciated problem with investing is "analysis paralysis": you can spend so much time trying to figure out the best way to do something that you end up doing nothing at all. Take rebalancing, viewed by many as an investment basic. First, you decide on a suitable asset allocation (say 60% equities, 40% bonds). Then, when the allocation gets too far out of line with your initial plan, as a result of market moves, you top up or sell the excess as necessary. So, if after a year 65% of your portfolio is in equities, and 35% is in bonds, you sell equities and buy bonds until you're back at 60/40.

That's all very well, you might think but then you start looking into it, and you find a huge range of conflicting views on rebalancing: when and how to do it, and whether to do it at all. So what's an investor to do? The main argument for rebalancing, as Buttonwood in The Economist puts it, is that "it works against the boom-bust cycle". In effect, it leads you to favour cheaper assets over expensive ones, which is surely good in the long run.

Or is it? Michael Edesess, chief investment strategist at Compendium Finance, is a dissenting voice. He argues that most researchers are too selective with their results. His data suggests that rebalancing does beat buy-and-hold by a little bit, roughly two-thirds of the time. However, on the remaining third of occasions, buy-and-hold wins out by quite a large margin. So in the long run, the two cancel each other out neither is best.

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So don't bother? It's not that simple. As I noted above, analysis paralysis is a big threat in investing. Rebalancing might not definitively beat buy-and-hold in theory, but it may well help you to steer clear of common investment mistakes, such as panic selling at the bottom or euphoria buying at the top. As Edesess himself put it on the Advisor Perspectives website: "Rebalancing is certainly not necessarily harmful It is better to have an investing discipline than not to have one, and rebalancing is one acceptable default discipline especially when the investor would fail to adhere to any discipline if his portfolio's volatility exceeded a particular level."

So arguably the real benefit to rebalancing is psychological it helps you stay the course when markets run into turbulence. Given that, and to avoid the temptation to fiddle too much, we'd suggest that rebalancing annually makes sense for most. Also, if you are saving regularly rather than managing a lump sum, it's probably most cost-effective to rebalance by adjusting your monthly (or quarterly) contributions in order to save more into the underweighted asset, rather than selling out of the overweighted one.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.