Maximize your Returns with Portfolio Rebalancing



Portfolio rebalancing is a crucial aspect of investing that helps investors maintain their desired asset allocation and manage risk. This process involves periodically adjusting the composition of an investment portfolio to ensure it remains aligned with the investor's goals and risk tolerance.

Maintaining target asset allocation

Market fluctuations and the performance of individual assets can cause your portfolio to drift away from your target allocation over time and your portfolio may become heavily skewed towards a particular asset class. Figure 1 shows the allocation drift of a 2-Fund portfolio that started with 60% US-Stock and 40% Long Term Treasury. The portfolio gradually shifted from 60-40 in 2003 to 82-18 by 2022 due to higher growth in the US stock market vis-a-vis the Long Term Treasury. Rebalancing your portfolio helps to maintain your desired asset allocation. 

 
Figure 1. Allocation shift of a 60-40 portfolio over a 20-year period

Managing risk

Rebalancing can also help to manage risk. As assets in your portfolio appreciate, their weighting in the portfolio increases. Rebalancing helps to manage this risk by selling assets that have appreciated in value and using the proceeds to purchase underperforming assets. This helps to ensure that your portfolio remains diversified and reduces the risk of a sudden decline in the value of your investments.

Maximizing returns

Rebalancing systematically ensures that the assets that are over-performing (expensive) are sold while the ones under-performing (cheap) are brought. This can result in increased returns over time, especially if you are invested in a well-diversified portfolio. Back-testing the 60-40 2-Fund Portfolio described earlier over a range of 20-year periods between 1986 and 2022, the portfolio with rebalancing outperformed the one with no rebalancing for almost every period, except for the 2003-2022 period where the former under-performed marginally relative to the latter (Figure 2). Averaging across the 20-year periods, annual rebalancing achieved an extra 9% portfolio value.

Figure 2. Final value of the 60% US-Stock, 40% Long Term Bond portfolio across 20-year periods between 1986 and 2022. Both the portfolios with and without rebalancing started with an initial investment of $1,000 and subsequent monthly contribution of $1,000.

Closing Remarks

In conclusion, rebalancing helps investors ensure their portfolios remain aligned with their goals and risk tolerance while maximizing returns. However, it is worth noting that Jack Bogle, the founder of Vanguard, advised against frequent portfolio rebalancing. He believed that frequent rebalancing could lead to unnecessary transaction costs (and taxes in some countries). As the saying goes, Moderation is the Key to Life.


The content shared in this post is just my opinion and should not be taken as financial advice. In fact, you should never treat what a random dude shared online as financial advice, no matter how credible he/she may sound.
Location: Singapore

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