The art (and importance) of rebalancing

scales with coins one side and a potato on the other

The art (and importance) of rebalancing

Rebalancing: “The tendency of professional portfolio managers to put money at risk at the beginning of the year and move out of risky stocks and into safer investments towards the end of the year in an effort to outperform benchmarks and secure a Christmas bonus.”

Definition from the FT’s lexicon

A somewhat cynical, and outdated, view of rebalancing perhaps?  It certainly does not reflect the reality of those who employ a disciplined rebalancing process, or the many benefits of employing such a process.

So far this year, equity markets have pretty much moved in only one direction – up.  At the time of writing, the MSCI International World Index is up 16.33%.

There are constant mumblings that world equity markets are due a correction.  I have absolutely no idea whether that is the case or not.  At Bloomsbury, we do not try to time the markets.  Nor do we make bets on which countries, sectors etc. we think will under- or out-perform the broad market.

So, what exactly do we do?  Well, aside from the ongoing background work we do in seeking to ensure that our philosophy remains valid (which is a constant process), our main activity in managing client portfolios happens around rebalancing.

Is rebalancing worth it?

I came across this article on rebalancing the other week, which I thought came up with some interesting points on the subject.  The article provides data for returns from a portfolio initially invested 70% in equities and 30% in bonds in 1988 (20% in the Vanguard 500 Index fund; 20% in the Vanguard Mid-Cap Index fund; 10% in the Vanguard Small-Cap Index fund; 20% in the Vanguard Total International Stock Index fund; and 30% in the Vanguard Total Bond Market Index fund), where three different strategies were employed:

  • Rebalancing at 5% thresholds (i.e. when the asset allocation breached 75/25 or 65/35);
  • No rebalancing and
  • Panic and sell when S&P 500 falls 20%.


There have been many studies carried out on the benefits of rebalancing and views differ as to whether or not one should do so.  Opinions also differ as to when such rebalancing should occur in order to maximise gains.

As can be seen from the article, the portfolio which was never rebalanced is the one which generated the highest returns.  Rebalancing produced the second highest returns and panic selling – perhaps unsurprisingly – produced the lowest level of returns.  In fact, in this exercise, panic selling destroyed wealth of over $400,000 in the period.

On the face of it then, perhaps you should just let your portfolio ride, letting the corrections which occur from time to time do the ‘rebalancing’ for you?  Well, that strategy may turn out to have costs of its own.

What are the benefits of rebalancing?

“People don’t want to rebalance when the stockmarket is doing well,” Colleen Jaconetti, a senior analyst with Vanguard’s Investment Strategy Group, said back in 2015, “but what if the stockmarket did drop 20% and they had not rebalanced?”

Whilst we like to think that we are rational beings, when it comes to our money we struggle to maintain a disciplined approach.  We are much more likely to fight with our emotions whenever the going gets a bit hairy.  During the period used in this article, the 70/30 investor would have experienced falls of up to almost 33%.  Weathering that and not panicking takes a lot of resolve.

You might think you are indeed that logical individual who will stay the course.  Sadly, unless you are hard wired to be a tremendous risk taker, the science is not in your favour.  As Ben Carlson explained recently in this blog post, when you are engaged in the activity of investing, your brain behaves as though you were taking hard core drugs.  Jason Zweig, the author referred to in this blog, actually had his brain studied while writing his book.

Market volatility creates a bumpy ride – rebalancing can help

Stock markets can display periods of quite extreme volatility.  The evidence indicates that most investors find that volatility very difficult to cope with.  The following chart, which looks at the flow of investor money into and out of US-based equity mutual funds in relation to the previous 12 month return from global equities, demonstrates this very well.

FIGURE 1:  US investors – inflows into equity funds – 2000-2014

Source: Investment Company Institute. Copyright © All rights reserved 2015

When markets go up, investors tend to buy, and when they fall, they tend to sell. Which is precisely the opposite of what you should do.

So, whilst great in theory, in practice the ‘no rebalancing’ approach would not work for many people, as the chances that you would experience levels of volatility much higher than that with which you could cope emotionally is too high.  Rebalancing your portfolio back to the asset allocation with which you can cope emotionally helps to avoid you being exposed to levels of volatility outside your comfort zone.

At Bloomsbury, we adopt an ‘emotion free’ approach.  This is both simple to monitor and easy to implement.  We adopt a disciplined approach to rebalancing, with client portfolios reviewed regularly and rebalanced when the weightings of component parts deviate significantly from their targets.

Rebalancing is not viewed as an enhancer of returns

We view rebalancing primarily as a risk management tool, not an enhancer of returns.  As we have discretionary permissions we can rebalance our clients’ portfolios without the need to consult with them first.  As a result, we remove all emotions from the decision.

We accept that by implementing a rebalancing strategy we may be ‘giving up’ some of the returns available.  However, we do so in the knowledge that this is a price worth paying to potentially enable our clients to be able to sleep at night and to have a rewarding investment experience.

With equity markets having risen substantially since the global financial crisis of 2008/09, many investors may well have seen their portfolios drift into waters which might be a bit choppier than they can cope with if we do see a downturn at some point.  If you haven’t rebalanced your portfolio for a while (or worse, have not even set yourself a target asset allocation), you might want to spend some time doing so.

A detailed explanation of our investment philosophy and process is provided in our Guide to Investing, which can be downloaded, free of charge from our website.

“The fundamental purpose of rebalancing lies in controlling risk, not enhancing return.  Rebalancing trades keep portfolios at long-term policy targets by reversing deviations resulting from asset class performance differentials.  Disciplined rebalancing activity requires a strong stomach and serious staying power.”

David Swensen, CIO Yale University Endowment

Warm regards