March 10, 2020 | Vanguard Perspective
Advisors recognize the value of periodic portfolio rebalancing to maintain their clients' target asset mix. After all, asset allocation has been shown to be the most important factor in determining long-term investing success.1
Yet clients often express resistance to the idea of rebalancing their portfolios. One of their most common objections: Why sell the winners and buy more of the assets that have less impressive returns? Why not do the precise opposite to reap maximum returns?
You can use our customizable guides to walk clients through the answers to those questions.
Best, worst, and average returns for various stock/bond allocations, 1997–2019
Over time, different asset classes have produced different returns and, correspondingly, different levels of volatility.
Annual returns by asset class, from the highest to the lowest, 1997–2019
Gaining buy-in from clients for strategies such as rebalancing can be as simple as providing them with a "why" that answers their questions or satisfies their objections. For instance, they may want to know more about your firm's rebalancing methodology—what is the process, how often does it happen, does it usually result in significant capital gains taxes or transaction costs, and how significant a risk reduction can they expect in return?
In considering these conversations, you might find Vanguard's rebalancing-related research to be a helpful reference.
Advisors have a range of options with which to approach rebalancing:
Time only—rebalancing on a set schedule, such as daily, monthly, quarterly, or annually.
Threshold only—rebalancing when a target asset allocation deviates by a predetermined percentage, such as 1%, 5%, or 10%.
Time and threshold—rebalancing on a set schedule, but only if a target asset allocation deviates by a predetermined amount, such as 1%, 5%, or 10%.
Many advisors use rebalancing software to eliminate any uncertainty over which option might yield the best outcome. Otherwise, the chosen approach can simply hinge upon your practice's preference.
By way of example, Vanguard performs a quarterly rebalancing review with advised clients. The Vanguard advisor analyzes a computer-generated report of investment recommendations for a client's portfolio, including recommended changes if the portfolio exceeds the target allocation by more than 5%. The advisor receives notification of the rebalancing activity and can discuss the changes with the client.
Rebalancing can also be combined with and complement other strategies, such as tax-loss harvesting. Vanguard research shows that advisors can add appreciable value over time, through activities such as rebalancing and behavioral coaching in general.2
In addition, Vanguard research has determined that none of the major rebalancing approaches holds a distinct or enduring advantage over the others. Therefore, the most important consideration is for advisors to apply rebalancing to client portfolios in a consistent and disciplined manner to give clients the best chance of reaching their long-term financial goals.
1 Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, 1995. "Determinants of portfolio performance." Financial Analysts Journal 51(1):133–8. (Feature Articles, 1985–1994.)
2 Francis M. Kinniry Jr., Colleen M. Jaconetti, Michael A. DiJoseph, Yan Zilbering, and Donald G. Bennyhoff, 2019. Putting a value on your value: Quantifying Vanguard Advisor's Alpha®. Valley Forge, Pa.: The Vanguard Group.