Daryanani, the developer of the highly regarded iRebal rebalancing software, wondered if how often one looked to see if the portfolio was out of balance affected his results. Among his conclusions were that rebalancing enhances returns and it was good practice to look more often but trade less frequently than one would with a traditional quarterly, semiannual, or annual rebalancing process.

Later in 2008, Marlena Lee at Dimensional Funds Advisors wrote "Rebalancing and Returns," in which she found a returns improved from rebalancing in many scenarios but less reliably than Daryanani's paper suggests. She found no optimal rebalancing rules that produced the highest returns on all portfolios in all time frames.

In the example where we start with $100,000 each in A and B, we keep a 50/50 target, and A earns nothing while B sinks 20%, the ratio of A to B is 55.6% to 44.4%. If having 55.6% is the trigger point, we would rebalance when A was 44.4% of the portfolio. Since we sold $10,000 of A to rebalance and A earns nothing, the portfolio would reach a trigger point when the total balance reached $202,702.70 ($90,000/.444).

A couple of paragraphs earlier, there was little reason to trade a $203,000 portfolio yet we're trading at just under that to restore the 50/50 mix and that action seems reasonable based on how far out of balance the portfolio became. That may be curious on its face but we are looking at two different time frames. In the first, B has risen 3% between looks, but we don't have any information about what happened in between the start and end points.

In the second there has been a notable drop in the value of B, but we aren't yet to the point where B has reached a value 3% higher than the start point when we rebalance. In fact, B is only about .18% higher than the start point, making an AB mix that did not rebalance worth roughly $200,184. By the time B is up 3%, the rebalanced portfolio would be worth $205,551 and a 49.31% to 50.69% ratio of A to B.  

Whether rebalancing like this is a plus for a client depends on several factors. It is true that the rebalanced mix produced a profit while both A and B had no change. In a taxable account, the ignored mix has a basis of $200,000, split evenly between A and B. The rebalanced portfolio has the same basis prior to the rebalancing at $202,720 but it is divided $90,000 to A and $110,000 to B. The amount of a gain incurred for tax purposes upon rebalancing depends on the accounting method used at that time, and the tax due is dependent on what else goes on the client's 1040 that year. Of course, if B continues to run, the rebalancing done at $202,702 would hurt returns from that point, as fewer shares would experience the rise.

Clearly, time frames affect one's view of the return benefits of rebalancing. I believe an increase in return is possible but I'm not sure that is the benefit that is the most reliable. I think the risk management elements of rebalancing are more compelling.

Whatever set of rebalancing rules one employs, it can encourage a behavior that makes sense. One largely maintains the exposures needed over the long term while buying a little of things at relatively low prices and selling a little at relatively high prices. The logic in that has great appeal but as important, it is a concept one can actually execute without depending on accurate market forecasts.

Having a rebalancing discipline can help address some of the emotional aspects of managing a portfolio. Properly educated about the matter, clients may be less inclined to get swept up in times of hype or dragged down in times of despair.

When conditions are particularly chaotic, many clients crave control. We cannot control when, or even whether, we are rewarded from risk taking but we can control the types and levels of risks that we bear and what we do when those risks reward or punish us.