The Value of an Advisor Part 5: Rebalancing

We discussed the importance of implementing an appropriate asset allocation in part 3 of our blog series. Given the importance of allocation, it’s also crucial to maintain that allocation over time. As time passes, the different investments of a portfolio produce different returns causing the overall allocation to drift from the initial allocation leading to new risk and return characteristics that may be inconsistent with client goals. Due to the equity risk premium, the fact that stocks provide higher returns than bonds over time, this drift causes portfolios to become much riskier. It is important to note that the goal of rebalancing is to minimize risk rather than maximize return. Done properly, Vanguard’s Advisor’s Alpha® study finds that a 60% stock/40% bond portfolio that is rebalanced annually adds up to 35 basis points (0.35%) in risk-adjusted average annual returns versus the same portfolio that is not rebalanced.

Dynamic Rebalancing

Our experience tells us that the aforementioned value-add is likely lower than what a dynamically rebalanced portfolio produces. Dynamic rebalancing is done by setting drift bands and allowing the portfolio’s allocation to move within these bands, rebalancing only when the bands are breached. A rebalancing strategy that follows only a calendar will often miss excellent rebalancing opportunities or force rebalancing trades when they are unnecessary. Unnecessary rebalancing incurs explicit and implicit costs that do very little to improve one’s investing experience. Historically, rebalancing opportunities have occurred when there has been a wide dispersion between the returns of different asset classes. Whether in bull or bear markets, moving assets from better-performing asset classes to the worst-performing ones feels very counterintuitive to many investors. A good advisor can provide the discipline to rebalance when it is needed most, which is often when the thought of moving money from something “good” to something “bad” can be a very uncomfortable leap of faith.

Stay tuned for our next post in our Value of an Advisor series: Behavioral Coaching.If you have any questions about rebalancing your portfolio, contact Claris.

Read Part 1: 7 Strategies to Quantifying Value
Read Part 2: Asset Location
Read Part 3: Asset Allocation
Read Part 4: Cost Effective Implementation

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