Rebalancing Checklist - Adviser Investments

Rebalancing Checklist

Rebalancing Reconsidered

In our last Adviser Fund Update, we put two rebalancing strategies—time-dependent and portfolio drift—recommended by Fidelity and Vanguard to the test. Running our own numbers, we found that over two-plus decades there was little difference in return between regular, periodic rebalancing, using allocation drift greater than 5% or 10%, and never rebalancing. For the details, please take a look at our January 16, 2015 update.

Readers responded with questions about taxes, trading fees and other potential costs involved with the rebalancing strategies we spotlighted. This week, we’ll take a look at these topics and some other issues to consider when plotting out a rebalancing scheme.

The Costs of Trading

The strongest argument against becoming a rebalancing fanatic? Cost. When conducting our analysis two weeks ago, we assumed that all distributions were reinvested along the way, and did not factor in transaction fees or taxes on realized gains from trades—two  important issues to consider when thinking about a rebalancing strategy.

If you choose to rebalance annually (or even more frequently) in a taxable portfolio, carefully review how the various transactions you’ll make will affect your tax return as well as any fees you might incur. Ask yourself these questions:

  • Do funds in your portfolio have front- or back-end loads or short-term trading fees?
  • Are you buying into a fund paying a distribution? (Some funds pay annually, others quarterly, for example.)
  • Will the sale of a fund create a taxable gain? (This is obviously not an issue in tax-free accounts like IRAs and 401(k)s, but trading fees and loads should still be considered.)

Answering these questions may help you realize that these hidden costs of rebalancing can quickly suck the wind out of your portfolio’s sails and be a drag on your returns.

However, there are more ways to rebalance than just buying and selling out of the funds in your portfolio on a fixed schedule or when allocations get out of whack. A simple idea is to consider redirecting distributions to or making new investments in the under-allocated funds in a portfolio. Or, if you’re at the point where you’re using the portfolio for income, you could sell more of your winners’ shares to reduce their allocation (this of course will generate its own tax bill, but you can’t avoid taxes forever if you’re drawing down your portfolio). These kinds of moves can be effective in keeping taxes and expenses down versus making numerous trades over the course of a year.

Maintaining Emotional Detachment

Don’t overlook the human factor with regard to rebalancing. It’s easy enough to calmly discuss rebalancing a hypothetical portfolio, but in reality, many investors may find the idea counterintuitive. It requires you to reward the losers in your portfolio with more money while reducing your exposure to proven winners.

If you have a fund in your portfolio that’s been outperforming month after month, you’re probably not going to want to sell it to invest more in a fund that’s been losing you money. But the standard theory of rebalancing requires that you do exactly that, and not just once, but over and over and over. As former Vanguard Chairman Jack Brennan put it: “If you are going to rebalance, you have to be absolutely clinical, or you are better off not doing it.”

Of course, you could take the more relaxed approach and rarely rebalance—if at all—so long as you have a tolerance for the increased volatility that is part of an “unbalanced” portfolio. And when you consider the tax bill on frequent trades, you could come out substantially ahead. As illustrated by our analysis, from a returns standpoint, going with the flow isn’t that bad of an idea.

Several additional things to consider:

  • If you do choose to rebalance, either on a schedule or when your portfolio’s allocation moves past a predetermined threshold, is your target allocation still appropriate? Do you still have the same investment goals as when you started? Has your risk comfort zone changed? Over the 28-year period such as the one we looked at last time, your allocation may no longer be a good fit, requiring even more buying and selling.
  • Are you prepared for the headaches and tax implications of making multiple trades per year? While many firms allow you to make trades online, you still open yourself up to having to review more paperwork, track all of the changes to make sure there weren’t any errors (on your part or the fund company’s) and fill out extra lines on your tax return for every capital gain realized. This could add up to a lot of extra hassle, and it may be the biggest deterrent to tax-sensitive investors.
  • If you’re following a portfolio drift scheme, will you be able to stay on top of your portfolio and trade at the right times? As we showed last time, you could be in for both flurries of trades over a short time period and years twiddling your thumbs by following this strategy. Since there’s no routine, you’ll need to pay close attention month in and month out to execute at the right times.

So is rebalancing necessary? The media or your fund company may have you thinking so, but when you look at the evidence—even after a six-year stretch as topsy-turvy as 2008 through 2014—there is little benefit when it comes to the portfolio’s returns, and only some benefit when you think about risk. (Again, assuming no tax consequences or trading fees.)

Of course, if rebalancing frequently gives you peace of mind and you’re willing to be clinical about it, your portfolio may not suffer too much for it either.


About Adviser Investments

Adviser Investments is a full service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994, and have more than 3,500 clients across the country and over $6 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, with particular expertise in Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To.

Our minimum account size is $350,000.  To see a full list of our awards and recognitions, click here, and for more information, please visit or call 800-492-6868.

Disclaimer: This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations, personal investment advice or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged.

Past performance is not an indication of future returns. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. We do not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.

The Barron’s rankings consider factors such as assets under management, revenue produced for the firm, regulatory record, quality of practice and philanthropic work. This award does not consider client experience and is not indicative of future performance.

Editors at the Financial Times bestowed “elite” status on 300 firms in the U.S., as determined by assets under management, asset growth, longevity, compliance record, industry certifications and online accessibility.

© 2018 Adviser Investments, LLC. All Rights Reserved.