The Virtues of Rebalancing

May 13, 2014

by Craig L. Israelsen, Ph.D.

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Does rebalancing improve portfolio performance? Yes – but it takes time for the benefits of rebalancing to be fully manifested, at least in the case of a broadly diversified 12-asset portfolio.

The analysis of rebalancing in this article will assume a 12-asset portfolio over a 16-year period from Jan. 1, 1998, to Dec. 31, 2013. Portfolio assets included in this analysis are large-capitalization U.S. equity, mid-capitalization U.S. equity, small-capitalization U.S. equity, non-U.S. equity (developed and emerging), real estate, natural resources, commodities, U.S. bonds, US Treasury Inflation-Protected Securities (TIPS), non-U.S. bonds, and cash. Each of the 12 asset classes is equally weighted at 8.33%. This 12-asset model is known as the 7Twelve® model. (I am the designer of this model.) It represents a diversified, multi-asset portfolio in which to test the merits of rebalancing.

Below in Table 1 is a quick summary of the performance based on various rebalancing assumptions:

  • No rebalancing (buy-and-hold)
  • Monthly rebalancing
  • Quarterly rebalancing
  • Annual rebalancing

The performance of 7Twelve® Portfolio is based upon the “passive” model that uses actual exchange-traded funds (ETFs). Performance is net of fees (i.e., the expense ratios of the various ETFs) but has not been adjusted for taxes or inflation. The cost of rebalancing was assumed to be zero – which is possible using a no-trading-fee (NTF) platform, such as that offered by Charles Schwab, Fidelity or Vanguard (if using Vanguard ETFs).

Table 1. Performance under various rebalancing assumptions
(Highest returns shown in bold)

Performance over
Multiple Time Frames

Multi-Asset Portfolio Performance

No
Rebalancing

Monthly
Rebalancing

Quarterly
Rebalancing

Annual
Rebalancing

3-Year Annualized % Return
(2011-2013)

6.34

6.20

6.33

6.33

5-Year Annualized % Return
(2009-2013)

11.88

11.49

11.61

11.45

10-Year Annualized % Return
(2004-2013)

7.54

7.98

8.16

8.17

15-Year Annualized % Return
(1999-2013)

8.08

8.20

8.38

8.44

16-Year Annualized % Return
(1998-2013)

7.34

7.81

7.99

8.05

Table 2. Rebalancing premium over rolling time periods
Numbers in (red) indicate a negative rebalancing premium (i.e., better results without rebalancing)


Rolling
Period Ending
in Year…

Rebalancing “Premium”
(Outperformance in basis points due to rebalancing annually versus buy-and-hold)

Rolling 3-Year

Rolling 5-Year

Rolling 10-Year

Rolling 15-Year

2000

116

2001

54

2002

(65)

83

2003

35

38

2004

9

(20)

2005

(97)

(11)

2006

(71)

(60)

2007

(62)

(149)

27

2008

99

83

24

2009

140

100

44

2010

153

119

33

2011

12

106

45

2012

2

88

34

71

2013

(1)

(43)

63

36

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