CFA Institute Advocates for Systematic Rebalancing

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Gautam Dhingra, Ph.D., CFA and Christopher J. Olson, CFA wrote a nice article on the value of systematic rebalancing for the The CFA Institute Contributors. In it, they say:

Would you rather be stuck in rush hour traffic or rebalance your portfolio?

It’s an odd question, no doubt. But odder still is the fact that 31% of investors would prefer to sit in gridlock than rebalance their portfolios.

Why is this response so disappointing? Because systematic rebalancing is one of the few opportunities for a nearly “free lunch” that the markets offer.

It is nice to have the CFA Institute confirming that systematic rebalancing offers a nearly free lunch to boost returns. Much disinformation and shoddy analysis have tried to argue that rebalacing is a myth, too emotionally difficult, or just overrated.

Rebalancing is the contrarian movement of selling what has gone up and purchasing what has gone down to return your portfolio to a target asset allocation.

That being said, to rebalance an investor needs a target asset allocation. Many (if not most) investors don’t have any investment strategy.  Instead, they just have a collection of investments. The best you get with a collection of investments is a buy and hold approach. Without an investment plan, investors are left evaluating each individual investment and never asking the question of how each component will move in or out of sync with the rest of the portfolio.

Investors seeking a rebalancing bonus, must begin with an investment policy statement that includes target allocations to different sectors and subsectors.

Many so-called advisors offer an asset allocation not because it is near the efficient frontier of long term investing but simply because it is a collection of commission-based products that have above average 5-year returns. Such a ‘portfolio’ has great consumer appeal because it has so soundly recently beaten the market. Advisors who have thrown together a collection of products also have no incentive to rebalance such a portfolio. Furthermore, such a portfolio may consist of funds which are highly correlated, and then, when the market turns, all the funds will do poorly together just as they all did well together.

Once you have a well-constructed portfolio, there is a discipline required to regular rebalancing. Rebalancing is the most helpful when it is most difficult. Knowing that rebalancing boosts returns is useless unless you have the time, discipline, and nerve to follow through and actually execute the trades.

Few investors have such discipline, and it is one of many areas where working with a competent personal financial advisor may bring more value than it costs.

Photo by Clint Adair on Unsplash

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President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.