Larry Macdonald has noted in his blog posting titled "No need for annual rebalancing" on Dec.3, 2007 a fascinating and shocking study "Optimal Rebalancing Frequency for Bond/Stock Portfolios" by David M. Smith and William Desormeau in the November 2006 Financial Planning Journal that seems to suggest an "almost never" approach is best. They studied the two popular approaches to rebalancing: at regular intervals (monthly, quarterly, yearly etc), or based on percentage deviation of asset values from the target (1%, 5%, 10% etc). They did this for a wide range of bond vs stock portfolio proportions using US data for the long period of 1926 to 2003.
Their conclusions are these:
"Rebalancing frequency and threshold level are associated with significant differences in portfolio scaled returns. We show that this is true across a wide range of policy weights. From the perspective of both frequency and threshold levels, patient rebalancing policies tend to dominate quick-trigger policies, even before trading costs and taxes are considered. If such costs were taken into account, the advantage in favor of patient policies would be even more dramatic."Scaled returns means returns that take account of returns relative to risk. Policy weights means the bond vs stock mixes. The threshold means that if bonds are meant to be 40% of the portfolio and the threshold is 10%, then rebalancing was only done if bonds went down below 30% (or above 50%) not when bonds went below 36% (10% of 40%).
They found that the optimal frequency using a time trigger was 44 months, or 3 years 8 months! For percentage deviation triggers, 5% or more was best; 10% was best or second best for about half the portfolio mixes (see table 2). And that is before transaction costs! I am bit puzzled by Figure 4, which if I read it right says that if one had adopted a 10% trigger for rebalancing, then no matter what the portfolio composition, during the whole period of 1926 to 2003, one would NEVER have had to rebalance. Or maybe, the graph is hard to read and it is less than 25 trades in 78 years. Either way that's astounding. Hello Rip, I see you've been a successful investor during your wee nap. Given that equities produce superior returns when calculated over long periods, I wonder how the portfolio could never have deviated that much from the targets.
Maybe the best rebalancing policy is above 10% deviation from target and only if new money added to the portfolio, or withdrawals from it, don't take care of bringing the portfolio allocation within the range. Isn't it good to know that being lazy can be a virtue?