• Rebalancing is an important component for successful multi-asset investing and ensures client portfolios remain within the desired risk profile over time.
• There are several ways advisers can implement rebalancing, including time-only, threshold-only and time and threshold.
• Being mindful of costs, taxes and cash flows can assist in making the rebalancing process as efficient as possible.

Portfolio rebalancing is one of the most underappreciated components of an effective multi-asset strategy. Although some investors might find the practice counterintuitive, there’s a good reason why Vanguard LifeStrategy ETFs are rebalanced on behalf of our investors.

In this article, we’ll explore why, how and when a multi-asset portfolio should be rebalanced.

What is rebalancing and how can it benefit clients?

In essence, rebalancing is the process of adjusting a portfolio’s mix of assets based on a fixed or dynamic¹ target asset allocation. Traditional multi-asset portfolios, like our LifeStrategy ETFs, employ a fixed-target allocation to global equities and global bonds—60% equities and 40% bonds being an historically popular split—and we’ll use this approach to examine the merits and considerations around portfolio rebalancing.

For fixed-target asset allocation strategies, portfolio rebalancing entails selling the best-performing securities in a portfolio over a given time period and using the proceeds to invest in the poorer-performing securities, with a view to maintaining the desired mix of equities and bonds in the portfolio.

While this might seem counterintuitive to some clients, the practice can help reduce portfolio volatility, avoid portfolio ‘drift’ and ultimately help investors stick to their long-term investment strategy. That’s because without systematically rebalancing, portfolio allocations can drift from their intended long-term target as the returns of constituent assets diverge, leading to much higher portfolio risk.

For example, a portfolio with an asset allocation of 60% global equities and 40% global bonds at the end of 2003, if never rebalanced, would have had 80% in equities at the end of 2022, as shown in the chart below. In contrast, an identical portfolio that was rebalanced at the end of each quarter would have maintained the target allocation and the desired risk profile over time.

Changes in stock exposure for a 60/40 rebalanced portfolio and a "drifting portfolio"

Past performance is not a reliable indicator of future results

Sources: Vanguard, using data from Bloomberg. Notes: Daily returns data from 1 January 2003 to 10 February 2022. The initial allocation for both portfolios is 42% US stocks, 18% international stocks, and 40% US bonds. The rebalanced portfolio is returned to this allocation at the start of each quarter. Returns for the US stock allocation are based on the Dow Jones US Total Stock Market Index until 1 April 2005 and on the MSCI US Broad Market Index thereafter. Returns for the international stock allocation are based on the MSCI All Country World Index ex USA and returns for the bond allocation are based on the Bloomberg US Aggregate Bond Index. All returns calculated in USD.

By allowing a portfolio to drift, clients may find their portfolios are more sensitive to stock market downturns, or equally could be left holding a portfolio which is no longer in line with their investment aims. This is where regular rebalancing can make a difference by keeping investors on track to meet their investment objectives.

Before we examine rebalancing strategies, it’s important to note that the primary function of portfolio rebalancing in the example outlined above is to keep a client’s investments aligned with their tolerance for risk – not to maximise returns.

But rebalancing can also be used with the intention of improving returns. In the case of time-varying asset allocation (or dynamic) strategies, rebalancing can also refer to the process of reviewing and adjusting the target mix of assets based on the latest medium-term forecasts. In this instance, portfolio rebalancing is intended to optimise portfolio returns according to a specific or broad investment objective, such as an annual return target or risk threshold.

Rebalancing options for advisers

The rebalanced portfolio in the chart above uses a simple time-only rebalancing strategy. Such a strategy rebalances on a given date, regardless of the relative performance of the portfolio’s component assets. But other approaches are available to advisers. For example, with a threshold-only strategy, rebalancing is triggered when a portfolio’s asset allocation has drifted by a given amount, say by five percentage points, irrespective of how often this happens.

A strategy combining a time and threshold approach will monitor the portfolio on a given schedule and have pre-set thresholds, but rebalancing will only occur when the two trigger-points intersect. Here’s a simple breakdown of three common approaches to 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 number of percentage points, 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 of percentage points, such as 1%, 5% or 10%.

Each approach has its own pros and cons based on individual circumstances, meaning advisers may want to research each technique thoroughly before selecting which one works best for each clients. Additionally, common pitfalls, such as chasing returns or taking too much risk, should be avoided when trying to rebalance portfolios.

Different rebalancing strategies may be better suited for different types of clients, portfolios and markets. For example, periodic rebalancing may be more beneficial for investors with larger portfolios compared with those with smaller ones, who may prefer trigger-based rebalancing strategies instead. By understanding these various strategies, advisers can tailor the approach to individual clients. Alternatively, multi-asset managers often provide an automatic rebalancing service on behalf of advisers as part of their multi-asset offering. For example, Vanguard’s LifeStrategy funds rebalance on a daily basis to ensure that the target asset allocation is maintained.

Is there an optimal approach to rebalancing?

Much research has been commissioned to attempt to identify the optimal rebalancing strategy, with mixed results. Vanguard’s latest research analysed the efficiency of annual, quarterly and monthly rebalancing strategies based on simulated market returns using our proprietary forecasting tool, the Vanguard Capital Markets Model (VCMM). The analysis considered cost-efficiency, portfolio volatility and post-transaction wealth as part of each approach’s overall efficiency.

During periods of heightened market volatility, less frequent portfolio rebalancing, i.e., annually, was found to be more efficient than quarterly or monthly approaches. That’s because transaction costs tend to rise during volatile environments², which makes rebalancing more costly. Moreover, an investor may rebalance in one direction and then have to reverse the transaction because the market swung sharply the opposite way, which can happen during periods of turmoil.

Broadly speaking, the analysis found that the optimal rebalancing method is one that is neither too frequent, such as monthly or quarterly calendar-based methods, nor too infrequent, such as rebalancing only every two years. But a more frequent approach, such as daily rebalancing, can also help clients achieve investment success, provided it is implemented in a consistent and cost-effective way.

Rebalancing tips for advisers

The responsibility is ultimately on advisers to identify the most appropriate rebalancing approach for clients and apply it in a consistent and disciplined manner to give them the best chance of reaching their long-term financial goals. There are certain actions and considerations that Vanguard recommends to maximise rebalancing efficiency, including:

Vanguard’s LifeStrategy ETFs are regularly rebalanced by our in-house investment teams in a disciplined and cost-effective way, giving advisers more time back to focus on other value-add tasks, such as behavioural coaching, for example.

¹ Dynamic, or time-varying, allocation strategies allow for some degree of flexibility on the target mix of assets to optimise portfolio returns according to the portfolio’s objective. These types of strategies take on active risk in the form of model-based asset allocation changes relative to a static benchmark.

² Vanguard calculations, based on data from FactSet. Notes: Analysis of actual and predicted bid-ask spread of securities within the S&P 500 between 1 January 2016 and 30 June 2020. See Y. Zhang, H. Ahluwalia, A. Ying, M. Rabinovich and A. Geysen, 2022 “Rational rebalancing: An analytical approach to multiasset portfolio rebalancing decisions and insights.”

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Some funds invest in emerging markets which can be more volatile than more established markets. As a result the value of your investment may rise or fall.Investments in smaller companies may be more volatile than investments in well-established blue chip companies.

ETF shares can be bought or sold only through a broker. Investing in ETFs entails stockbroker commission and a bid- offer spread which should be considered fully before investing.

Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.

The Funds may use derivatives in order to reduce risk or cost and/or generate extra income or growth. The use of derivatives could increase or reduce exposure to underlying assets and result in greater fluctuations of the Fund's net asset value. A derivative is a financial contract whose value is based on the value of a financial asset (such as a share, bond, or currency) or a market index.

Some funds invest in securities which are denominated in different currencies. Movements in currency exchange rates can affect the return of investments.

For further information on risks please see the “Risk Factors” section of the prospectus on our website.

Important information

This is a marketing communication.

This article is directed at professional investors and should not be distributed to or relied upon by, retail investors.

For further information on the fund's investment policies and risks, please refer to the prospectus of the UCITS and to the KIID (for UK, Channel Islands, Isle of Man investors) and to the KID (for European investors) before making any final investment decisions. The KIID and KID for this fund are available in local languages, alongside the prospectus via Vanguard’s website.

The information contained herein is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information is general in nature and does not constitute legal, tax, or investment advice. 

Vanguard Funds plc has been authorised by the Central Bank of Ireland as a UCITS and has been registered for public distribution in certain EEA countries and the UK. Prospective investors are referred to the Funds' prospectus for further information. Prospective investors are also urged to consult their own professional advisers on the implications of making an investment in, and holding or disposing shares of the Funds and the receipt of distributions with respect to such shares under the law of the countries in which they are liable to taxation.

The Manager of Vanguard Funds plc is Vanguard Group (Ireland) Limited. Vanguard Asset Management, Limited is a distributor for Vanguard Funds plc.

The Manager of the Ireland domiciled funds may determine to terminate any arrangements made for marketing the shares in one or more jurisdictions in accordance with the UCITS Directive, as may be amended from time-to-time.

The Indicative Net Asset Value (“iNAV”) for Vanguard’s ETFs is published on Bloomberg or Reuters. Refer to the Portfolio Holdings Policy.

For investors in Ireland domiciled funds, a summary of investor rights. is available in English, German, French, Spanish, Dutch and Italian.

For Dutch investors only: The fund(s) referred to herein are listed in the AFM register as defined in section 1:107 Dutch Financial Supervision Act (Wet op het financieel toezicht).For details of the Risk indicator for each fund listed, please see the fact sheet(s) which are available from Vanguard via our website.

Issued in EEA by Vanguard Group (Ireland) Limited which is regulated in Ireland by the Central Bank of Ireland.

© 2024 Vanguard Group (Ireland) Limited. All rights reserved.