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Rebalanicng Guideline - plus explanations
pvann 01-20-2004, 4:47 PM | Post #102207 | 
There has been some volume of work written on rebalancing portfolios, in particular
  • why rebalance
  • when to rebalance and how
  • the rebalancing bonus
eg see links in post 19 of conversation # 32060

Following some recent posts on this topic and noting some confusion, I thought it may be worthwhile to list and explain some simple guidelines. These are based on experience* I have in managing large wholesale rebalancing mandates, and I note the views of LarryS.

In summary, a practical and simple set of rebalancing rules can be based on the following:

  • use cash in-flows, income, distributions etc to increase your most underweight assets (ie underweight relative to your target set of asset weights)

  • use cash out-flows to reduce your most overweight assets

  • set asset weight limits at 5% each side of your target weights

  • regularly monitor your portfolio weights and if any move outside your limits and current or near term expected cash flows can not rectify this, then rebalance asset weights which are outside your limits towards your target allocation, but only go approximately half way between your target and your limit - this is more cost effective than full rebalancing

  • remember that rebalancing is about controlling the risk that your portfolio's performance may deviate from that implied in your investment strategy and since it may incur transaction costs (including possible early realization of capital gains) , you have to be pragmatic in balancing costs and risk control.

These few points are expanded in the following three posts as they all wouldn't fit in one post.

Lastly, I should point out that the often cited rebalancing bonus is a myth since is involves an invalid comparison to calculate the so-called "bonus".


* An investment management unit I ran in County Investment Management in Sydney Australia in the latter half of the 90s had a number of large rebalancing mandates. Thus we undertook a considerable amount of theoretical research into rebalancing strategies, costs involved, risks and this resulted in significant practical expertise. It is some of this knowledge that I will draw upon in this discussion.

Originally posted in thread: 32527
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