Smart Portfolios 8 – Rebalancing

Smart Portfolios 8 – Rebalancing

Today’s post is our eighth visit to Rob Carver’s book Smart Portfolios.

Rebalancing

The fourth and final part of Rob’s book is about rebalancing.

There are three reasons for rebalancing:

  1. periodic correction of portfolio drift
    • from changes in asset values, dividends, new cash, takeovers, delistings (even bankruptcies) etc.
  2. a change in your target allocations
    • for example to access new asset classes that were previously unavailable to the private investor
    • or to subdivide asset groups as members become less correlated or change in relative size – the last change I made was to split China off from the general EM block
  3. changing volatilities or correlations
    • since we are using very long-term values for these, we should not need to make changes very often, if at all

The fourth reason for rebalancing would be to overlay Rob’s return forecast rules (for Cutting costs

Rob approaches the costs of rebalancing by looking at the annual portfolio turnover implied by various rebalancing strategies.

  • Even a baseline level of rebalancing (to correct portfolio drift) implies 20% turnover (10% sold and re-bought).

To keep trading costs down, Rob offers two approaches.

The first is the no-trade zone.

  • Here you simply ignore rebalancing until the gap between ideal and actual reaches a predetermined percentage.

Rob suggests a 2% buffer (1% in each direction away from ideal), but my instinct would be to use half of the minimum allocation size in the weighting plan.

  • So if you have no assets that make up less than 2% of your plan, a 1% adjustment step would make sense.

Later on, Rob suggests that half of the average allocation is the best size.

  • So with 50 assets, the average allocation would be 2% and the adjustment step would be 1%.

A third approach (which I actually use) is a minimum trade size.

  • With a large portfolio, this is a more fine-grained approach (for example, my minimum trade size is 0.16% of my overall portfolio or 0.43% of my core passive portfolio.

Not also that rebalancing costs are lower (as an annual percentage) for larger portfolios, as larger trades are more efficient.


Rob suggests that annual rebalancing is enough for private investors.

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