Portfolio Rebalancing: A 22 Year Study

by: Lowell Herr

Does it pay to rebalance a portfolio and if so, what is the optimal target limit or threshold percentage? How frequently should one rebalance? This study leaves the second question open for further testing, but it answers the more important one of finding the optimal target limits. The 22-year study covers a period from 1989 through 2011. The beginning date was selected as that is when accurate data was available for these eight asset classes.

The eight asset classes selected were: Large-Cap Value, Mid-Cap Value, Small-Cap Value, Large-Cap Growth, Mid-Cap Growth, Small-Cap Growth, International Markets, and Domestic Real Estate. The amount allocated to each asset class was $10,000 making up an $80,000 portfolio. The portfolio was rebalanced at the end of the calendar year (if necessary) bringing each asset class back to 12.5% of the total portfolio.

In the following data, the annual rebalance occurred at the end of the calendar year so no asset class was permitted to run within a specified threshold percentage. In contrast, a 25% trigger assumed the asset class was in balance so long as the amount did not cross either above or below the 25% target limit or threshold. While the 25% trigger produced the best results, the 35% trigger is not far behind and it reduces the number of rebalancing events from seven (7) down to four (4). While we did not test it, one can assume the number of trades would be even lower if one were to reinvest dividends in the asset classes most under target.

From the initial $80,000 portfolio in 1989, the following annual balances are shown below.

Annual rebalance $562,332 (no trigger)
20% trigger $564,613
25% trigger $593,467
30% trigger $579,020
35% trigger $584,174

Peak values
Annual rebalance $596,979 (no trigger)
20% trigger $602,404
25% trigger $629,838
30% trigger $618,169
35% trigger $623,572

Number of rebalances in 22 years
20% trigger 9
25% trigger 7
30% trigger 6
35% trigger 4

At the end of 2006 (start date 1989) the annualized yield was 11.8%

2007 = 11.25%
2008 = 8.15%
2009 = 9.05%
2010 = 9.5%
2011 = 9.0%

It comes as no surprise that the portfolio peaked in 2007 or just before the bear market of 2008.

Inside the TLH Spreadsheet (frequently discussed on my blog at itawealthmanagement.com) is a dashboard laying out the portfolio asset allocation plan with the option to set one of the above trigger percentages. Most spreadsheet users apply the 25% threshold value, although some will go with the 35% trigger, particularly in taxable accounts where one desires fewer trades.

Instead of rebalancing once a year, I set threshold limits between 25% and 35%, depending on the portfolio, and rebalance when an asset class moves either above or below the specified target limit. It is not unusual for a portfolio to go more than a year without any need to rebalance if one reinvests dividends in the asset classes most under target.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Robert Warasila contributed extensively in analyzing the data, particularly in years 2006 through 2011.