A balanced view of rebalancing

Posted by Robin Powell on January 10, 2017


There is no single best way to invest. Everyone of us, after all, is different. And although the key principles are irrefutable — the benefits of diversification, for example, or the importance of cost — there are some grey areas. One of those areas is portfolio rebalancing.

I should put my cards on the table. I’m a fan of rebalancing, and I’m guessing that around 90% of what I would call evidence-based investors and advisers are fans of it as well. But many aren’t, and I’m absolutely fine with that. Hey, even Jack Bogle told me he doesn’t do it, and I’m not going to argue with him.     

But is rebalancing best practice or not? Well, it all depends on the reason for doing it. For me, the only reason for doing it is to restore your portfolio to the original asset allocation. If you don’t, the danger is that, over time, you’ll end up taking more risk than you can afford to, or that you’re comfortable with; on the other hand, of course, you might be taking less risk than you want to, or indeed less than you need to. Rebalancing ensures a smoother path towards your goals.

For others, though, there is another motivation behind it, and that’s to maximise returns. The question is, does rebalancing produce bigger returns than doing nothing and leaving your portfolio, for years on end, exactly as it is?

This issue is addressed in a recent article in the Wall Street Journal, which cites research suggesting that, as far as returns are concerned, rebalancing is no better or no worse a strategy than buy-and-hold.

The study was conducted by Dr Michael Edesess, chief investment strategist at Compendium Finance and research associate at the Edhec-Risk Institute, and produced similar findings to those of Andrew Wise. Dr Edesess describes Wise’s paper on rebalancing in the British Actuarial Journal in 1996 as “the best technical article on portfolio rebalancing by a very wide margin”.

This is what he says:

“(Wise) deduced that a rebalancing strategy will beat a buy-and-hold strategy about two thirds of the time, when the constituent assets in the portfolio have the same expected return.

“When buy-and-hold beats rebalancing, however, it beats it by a much larger margin, so that the average returns to rebalancing and to buy-and-hold, in the equal expected returns case, are the same.

“Contrary to common belief and to the misguided conclusions of most of the articles in academic finance journals, rebalancing offers no ‘free lunch’ .. in terms of enhanced return. The choice of rebalancing as an investment discipline as compared with an alternative such as buy-and-hold is simply a risk-return trade-off.”

To be honest, I don’t have a sufficiently mathematical brain to understand fully the arguments expounded by Dr Edesess and Andrew Wise, and doubtless the debate will continue.

Suffice it to say, I remain a proponent of rebalancing. The right investment strategy for any given person is the strategy that enables them to stick to the plan. If periodically rebalancing — say, once or twice a year — helps you to stay the course when others are abandoning theirs, then it is definitely worth doing.

That said, remember the purpose behind it. You rebalance to make your investing journey smoother, not to increase your return.



Robin Powell

Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.


How can tebi help you?