Ask any financial planner about rebalancing your investment portfolio and he or she will invariably tell you it’s a good thing.  Indeed, there’s a popular cant that goes something like “if you don’t rebalance your portfolio periodically, the market will do it for you.”  In 2015 I posted an article supporting rebalancing from a non-academic perspective (Does Rebalancing Your Portfolio Really Work?).  But is there any research that shows the impact rebalancing is actually expected to have on your portfolio, and how frequently it should be done?  Yes, but it’s not especially conclusive.

One of the more definitive analyses I could find on rebalancing’s impact on portfolio returns was performed by William Bernstein in 1996.  In a paper titled THE REBALANCING BONUS: Theory and Practice, Bernstein concluded that is it possible to generate higher returns through rebalancing, but only when the assets within the portfolio have high volatility and low correlations with each other.   With regards to frequency, he did not find any period (monthly, quarterly, or yearly) that proved to be superior under all circumstances.  Here’s a link to the paper:  http://www.efficientfrontier.com/ef/996/rebal.htm.

On the other side we have “Portfolio Rebalancing – Hype or Hope?” a 2015 study from Ajit Dayanandan and Minh Lam.  Their finding was that the mean difference between various periodic rebalancing strategies and a buy-and-hold strategy was not statistically significant except with quarterly or semi-annual frequencies.  And after subtracting the transaction costs and taxes, the additional returns became insignificant.  Their conclusion was that while there may be a case for portfolio rebalancing under certain circumstances such as for asset rotation during business cycles, active rebalancing does not provide long-term outperformance.  Here is their paper:  https://www.uvu.edu/woodbury/docs/jbi-vol14-2-2.pdf.

However, rebalancing is really not about trying to generate higher returns but rather about minimizing risk (or drift) relative to a target asset allocation, which is the single most important factor in investment portfolio management.  A 2010 rebalancing research note from Vanguard (the mutual fund company) addresses the question from this risk perspective.  Vanguard determined that risk-adjusted returns are not meaningfully different whether a portfolio is rebalanced monthly, quarterly, or annually.  But when taking into account the associated costs as above (taxes, time, and labor), annual or semiannual monitoring is likely to produce a reasonable balance between risk control and cost minimization for most investors.   They also introduce the concept of rebalancing when asset classes exceed pre-determined thresholds, rather than at fixed times on the calendar.  Utilizing 5% thresholds together with annual rebalancing is their preferred solution.  See details here:  http://www.vanguard.com/pdf/icrpr.pdf.

Investors should also be aware of the psychological effect of rebalancing, especially when working with advisors.  The lack of activity in a portfolio over a relatively long time can create the perception that it’s not being well-managed.  And whenever market volatility increases, investors tend to develop a strong propensity for action.  When viewed as a periodic, formulaic approach to investment portfolio management, rebalancing can be an effective way to address the need for action while keeping emotions out of the decision.

Can we definitively conclude that rebalancing works?  Not based on my standard of scientific rigor.  Nonetheless, when done correctly, it has been shown to help manage portfolio risk and investor behavioral biases, and sometimes even improve returns.  Sounds like an activity worth doing!