Rebalancing can help investors maintain an asset allocation that aligns with their needs, goals, and risk tolerances. The appropriate approach to rebalancing depends on where an investor sits in the tradeoff between rebalancing costs1 and deviations from the target asset allocation. Evaluating an array of rebalancing methods using four decades of historical data, our recent study “Portfolio Rebalancing: Tradeoffs and Decisions” suggests that rebalancing approaches that deviate from calendar-based trading and instead base rebalancing decisions on portfolio composition may produce better tradeoffs for investors.
WEIGHING YOUR OPTIONS
Reducing rebalancing costs and minimizing deviations from a target allocation represent conflicting goals. More frequent rebalancing may keep a portfolio tightly aligned with its target but at the cost of greater turnover. Less frequent rebalancing may lower costs but lead to larger tracking deviations.
Exhibit 1 illustrates this tradeoff. For a US 60/40 portfolio from 1979 to 2019, rebalancing quarterly produced about twice the turnover—our proxy for rebalancing costs—of rebalancing annually. But with that higher cost came a much lower tracking deviation from the target 60/40 allocation—less than half that experienced with annual rebalancing. Exhibit 1 also shows that calendar-based approaches, while convenient, tend to lead to less efficient rebalancing tradeoffs—higher turnover for a given level of tracking error and vice versa—compared to rebalancing with tolerance bands. As detailed in our paper, further improvements can be gained with tiered approaches that apply different tolerance bands across and within asset classes.
In evaluating how rebalancing choices may impact a portfolio’s short-term performance, we find that less frequent rebalancing does not necessarily lead to higher maximum drawdowns. However, rebalancing less frequently can lead to meaningful short-term return differences relative to the target asset allocation. Our results show that the range of tracking error across rebalancing approaches is wider for portfolios with larger equity allocations, suggesting that investors sensitive to tracking error should be particularly mindful when choosing rebalancing approaches if their portfolios have high allocations to equities.
When choosing between investing in an integrated portfolio solution and investing in a portfolio with many components, investors should take into account rebalancing costs; a multicomponent portfolio can incur meaningfully higher costs due to rebalancing, but with little expected difference in returns compared to an integrated portfolio with otherwise similar characteristics.
Furthermore, we do not find evidence that rebalancing choices can reliably increase expected returns. Realized return differences across rebalancing approaches are typically due to style drift. For example, more frequent rebalancing tends to reduce returns because rebalancing tends to reduce the allocation to asset classes with higher expected returns. However, if a greater allocation to higher-expected-return asset classes was appropriate, it should be reflected in the target allocation. Noise in returns can also impact the realized return outcomes of different rebalancing approaches, suggesting that investors should avoid choosing a rebalancing method based solely on historical returns.
There are no one-size-fits-all, universally optimal rebalancing approaches. Our recent paper provides a framework that can help investors strike the right balance between minimizing rebalancing costs and keeping a better focus on their investment objectives, which may better position them to capture what the market has to offer.
GLOSSARY Tolerance bands: A percentage range around a portfolio’s target allocation that determines when to rebalance a portfolio. Rebalancing occurs if the weight of any portfolio component deviates from its target weight by more than the specified tolerance. For example, with a 5% tolerance band, a portfolio targeting 60% in equities and 40% in fixed income is rebalanced if the portfolio weight of equities either exceeds 65% or falls below 55%. Tracking error: A measure used to quantify how closely a portfolio follows an index or benchmark, often defined as the standard deviation of the difference between the portfolio and index returns.
1. Rebalancing costs can take various forms and include explicit and implicit costs. Even in a market environment where many exchange-traded funds (ETFs) are traded with zero transaction fees, rebalancing can be costly for investors due to ETF spreads, taxes, and monitoring costs.
The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
UNITED STATES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
Investment products: • Not FDIC Insured • Not Bank Guaranteed • May Lose Value Dimensional Fund Advisors does not have any bank affiliates.
CANADA: These materials have been prepared by Dimensional Fund Advisors Canada ULC. Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Unless otherwise noted, any indicated total rates of return reflect the historical annual compounded total returns, including changes in share or unit value and reinvestment of all dividends or other distributions, and do not take into account sales, redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.
AUSTRALIA and NEW ZEALAND: This material is issued by DFA Australia Limited (AFS License No. 238093, ABN 46 065 937 671). This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person. Accordingly, to the extent this material constitutes general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. Investors should also consider the Product Disclosure Statement (PDS) and the target market determination (TMD) that has been made for each financial product either issued or distributed by DFA Australia Limited prior to acquiring or continuing to hold any investment. Go to au.dimensional.com/funds to access a copy of the PDS or the relevant TMD. Any opinions expressed in this material reflect our judgement at the date of publication and are subject to change.
WHERE ISSUED BY DIMENSIONAL IRELAND LIMITED OR DIMENSIONAL FUND ADVISORS LTD. Neither Dimensional Ireland Limited (DIL) nor Dimensional Fund Advisors Ltd. (DFAL), as applicable (each an “Issuing Entity,” as the context requires), give financial advice. You are responsible for deciding whether an investment is suitable for your personal circumstances, and we recommend that a financial adviser helps you with that decision.
NOTICE TO INVESTORS IN SWITZERLAND: This is an advertising document.
WHERE ISSUED BY DIMENSIONAL IRELAND LIMITED Issued by Dimensional Ireland Limited (DIL), with registered office 10 Earlsfort Terrace, Dublin 2, D02 T380, Ireland. DIL is regulated by the Central Bank of Ireland (Registration No. C185067). Information and opinions presented in this material have been obtained or derived from sources believed by DIL to be reliable, and DIL has reasonable grounds to believe that all factual information herein is true as at the date of this document.
DIL issues information and materials in English and may also issue information and materials in certain other languages. The recipient’s continued acceptance of information and materials from DIL will constitute the recipient’s consent to be provided with such information and materials, where relevant, in more than one language.
WHERE ISSUED BY DIMENSIONAL FUND ADVISORS LTD. Issued by Dimensional Fund Advisors Ltd. (DFAL), 20 Triton Street, Regent’s Place, London, NW1 3BF. DFAL is authorised and regulated by the Financial Conduct Authority (FCA). Information and opinions presented in this material have been obtained or derived from sources believed by DFAL to be reliable, and DFAL has reasonable grounds to believe that all factual information herein is true as at the date of this document.
DFAL issues information and materials in English and may also issue information and materials in certain other languages. The recipient’s continued acceptance of information and materials from DFAL will constitute the recipient’s consent to be provided with such information and materials, where relevant, in more than one language.
RISKS Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
JAPAN Provided for institutional investors only. This document is deemed to be issued by Dimensional Japan Ltd., which is regulated by the Financial Services Agency of Japan and is registered as a Financial Instruments Firm conducting Investment Management Business and Investment Advisory and Agency Business. This material is solely for informational purposes only and shall not constitute an offer to sell or the solicitation to buy securities or enter into investment advisory contracts. The material in this article and any content contained herein may not be reproduced, copied, modified, transferred, disclosed, or used in any way not expressly permitted by Dimensional Japan Ltd. in writing. All expressions of opinion are subject to change without notice.
Dimensional Japan Ltd. Director of Kanto Local Finance Bureau (FIBO) No. 2683 Membership: Japan Investment Advisers Association
FOR PROFESSIONAL INVESTORS IN HONG KONG. This material is deemed to be issued by Dimensional Hong Kong Limited (CE No. BJE760) (“Dimensional Hong Kong”), which is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
This material should only be provided to “professional investors” (as defined in the Securities and Futures Ordinance [Chapter 571 of the Laws of Hong Kong] and its subsidiary legislation) and is not for use with the public. This material is not directed to any person in any jurisdiction where (by reason of that person’s nationality, residence, or otherwise) the publication or availability of this material are prohibited or which would subject Dimensional Hong Kong (including its affiliates) or any of Dimensional Hong Kong’s products or services to any registration, licensing, or other such legal requirements within such jurisdiction or country. When provided to prospective investors, this material forms part of, and must be provided together with, applicable fund offering materials. This material must not be provided to prospective investors on a standalone basis. Before acting on any information in this material, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice.
Unauthorized copying, reproducing, duplicating, or transmitting of this material are prohibited. This material and the distribution of this material are not intended to constitute and do not constitute an offer or an invitation to offer to the Hong Kong public to acquire, dispose of, subscribe for, or underwrite any securities, structured products, or related financial products or instruments nor investment advice thereto. Any opinions and views expressed herein are subject to change. Neither Dimensional Hong Kong nor its affiliates shall be responsible or held responsible for any content prepared by financial advisors. Financial advisors in Hong Kong shall not actively market the services of Dimensional Hong Kong or its affiliates to the Hong Kong public.
SINGAPORE This material is deemed to be issued by Dimensional Fund Advisors Pte. Ltd., which is regulated by the Monetary Authority of Singapore and holds a capital markets services license for fund management.
This advertisement has not been reviewed by the Monetary Authority of Singapore. This information should not be considered investment advice or an offer of any security for sale. All information is given in good faith without any warranty and is not intended to provide professional, investment, or any other type of advice or recommendation and does not take into account the particular investment objectives, financial situation, or needs of individual recipients. Before acting on any information in this material, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice. Dimensional Fund Advisors Pte. Ltd. does not accept any responsibility and cannot be held liable for any person’s use of or reliance on the information and opinions contained herein. Neither Dimensional Fund Advisors Pte. Ltd. nor its affiliates shall be responsible or held responsible for any content prepared by financial advisors.
Finding Your Balance: Tradeoffs and Decisions in Portfolio Rebalancing
Rebalancing can help investors maintain an asset allocation that aligns with their needs, goals, and risk tolerances. The appropriate approach to rebalancing depends on where an investor sits in the tradeoff between rebalancing costs1 and deviations from the target asset allocation. Evaluating an array of rebalancing methods using four decades of historical data, our recent study “Portfolio Rebalancing: Tradeoffs and Decisions” suggests that rebalancing approaches that deviate from calendar-based trading and instead base rebalancing decisions on portfolio composition may produce better tradeoffs for investors.
WEIGHING YOUR OPTIONS
Reducing rebalancing costs and minimizing deviations from a target allocation represent conflicting goals. More frequent rebalancing may keep a portfolio tightly aligned with its target but at the cost of greater turnover. Less frequent rebalancing may lower costs but lead to larger tracking deviations.
Exhibit 1 illustrates this tradeoff. For a US 60/40 portfolio from 1979 to 2019, rebalancing quarterly produced about twice the turnover—our proxy for rebalancing costs—of rebalancing annually. But with that higher cost came a much lower tracking deviation from the target 60/40 allocation—less than half that experienced with annual rebalancing. Exhibit 1 also shows that calendar-based approaches, while convenient, tend to lead to less efficient rebalancing tradeoffs—higher turnover for a given level of tracking error and vice versa—compared to rebalancing with tolerance bands. As detailed in our paper, further improvements can be gained with tiered approaches that apply different tolerance bands across and within asset classes.
In evaluating how rebalancing choices may impact a portfolio’s short-term performance, we find that less frequent rebalancing does not necessarily lead to higher maximum drawdowns. However, rebalancing less frequently can lead to meaningful short-term return differences relative to the target asset allocation. Our results show that the range of tracking error across rebalancing approaches is wider for portfolios with larger equity allocations, suggesting that investors sensitive to tracking error should be particularly mindful when choosing rebalancing approaches if their portfolios have high allocations to equities.
When choosing between investing in an integrated portfolio solution and investing in a portfolio with many components, investors should take into account rebalancing costs; a multicomponent portfolio can incur meaningfully higher costs due to rebalancing, but with little expected difference in returns compared to an integrated portfolio with otherwise similar characteristics.
Furthermore, we do not find evidence that rebalancing choices can reliably increase expected returns. Realized return differences across rebalancing approaches are typically due to style drift. For example, more frequent rebalancing tends to reduce returns because rebalancing tends to reduce the allocation to asset classes with higher expected returns. However, if a greater allocation to higher-expected-return asset classes was appropriate, it should be reflected in the target allocation. Noise in returns can also impact the realized return outcomes of different rebalancing approaches, suggesting that investors should avoid choosing a rebalancing method based solely on historical returns.
There are no one-size-fits-all, universally optimal rebalancing approaches. Our recent paper provides a framework that can help investors strike the right balance between minimizing rebalancing costs and keeping a better focus on their investment objectives, which may better position them to capture what the market has to offer.
VIEW THE RESEARCH ON SSRN
GLOSSARY
Tolerance bands: A percentage range around a portfolio’s target allocation that determines when to rebalance a portfolio. Rebalancing occurs if the weight of any portfolio component deviates from its target weight by more than the specified tolerance. For example, with a 5% tolerance band, a portfolio targeting 60% in equities and 40% in fixed income is rebalanced if the portfolio weight of equities either exceeds 65% or falls below 55%.
Tracking error: A measure used to quantify how closely a portfolio follows an index or benchmark, often defined as the standard deviation of the difference between the portfolio and index returns.
1. Rebalancing costs can take various forms and include explicit and implicit costs. Even in a market environment where many exchange-traded funds (ETFs) are traded with zero transaction fees, rebalancing can be costly for investors due to ETF spreads, taxes, and monitoring costs.
The information in this document is provided in good faith without any warranty and is intended for the recipient’s background information only. It does not constitute investment advice, recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized copying, reproducing, duplicating, or transmitting of this document are strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
UNITED STATES: Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
Investment products: • Not FDIC Insured • Not Bank Guaranteed • May Lose Value
Dimensional Fund Advisors does not have any bank affiliates.
CANADA: These materials have been prepared by Dimensional Fund Advisors Canada ULC. Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Unless otherwise noted, any indicated total rates of return reflect the historical annual compounded total returns, including changes in share or unit value and reinvestment of all dividends or other distributions, and do not take into account sales, redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.
AUSTRALIA and NEW ZEALAND: This material is issued by DFA Australia Limited (AFS License No. 238093, ABN 46 065 937 671). This material is provided for information only. No account has been taken of the objectives, financial situation or needs of any particular person. Accordingly, to the extent this material constitutes general financial product advice, investors should, before acting on the advice, consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation and needs. Investors should also consider the Product Disclosure Statement (PDS) and the target market determination (TMD) that has been made for each financial product either issued or distributed by DFA Australia Limited prior to acquiring or continuing to hold any investment. Go to au.dimensional.com/funds to access a copy of the PDS or the relevant TMD. Any opinions expressed in this material reflect our judgement at the date of publication and are subject to change.
WHERE ISSUED BY DIMENSIONAL IRELAND LIMITED OR DIMENSIONAL FUND ADVISORS LTD.
Neither Dimensional Ireland Limited (DIL) nor Dimensional Fund Advisors Ltd. (DFAL), as applicable (each an “Issuing Entity,” as the context requires), give financial advice. You are responsible for deciding whether an investment is suitable for your personal circumstances, and we recommend that a financial adviser helps you with that decision.
NOTICE TO INVESTORS IN SWITZERLAND: This is an advertising document.
WHERE ISSUED BY DIMENSIONAL IRELAND LIMITED
Issued by Dimensional Ireland Limited (DIL), with registered office 10 Earlsfort Terrace, Dublin 2, D02 T380, Ireland. DIL is regulated by the Central Bank of Ireland (Registration No. C185067). Information and opinions presented in this material have been obtained or derived from sources believed by DIL to be reliable, and DIL has reasonable grounds to believe that all factual information herein is true as at the date of this document.
DIL issues information and materials in English and may also issue information and materials in certain other languages. The recipient’s continued acceptance of information and materials from DIL will constitute the recipient’s consent to be provided with such information and materials, where relevant, in more than one language.
WHERE ISSUED BY DIMENSIONAL FUND ADVISORS LTD.
Issued by Dimensional Fund Advisors Ltd. (DFAL), 20 Triton Street, Regent’s Place, London, NW1 3BF. DFAL is authorised and regulated by the Financial Conduct Authority (FCA). Information and opinions presented in this material have been obtained or derived from sources believed by DFAL to be reliable, and DFAL has reasonable grounds to believe that all factual information herein is true as at the date of this document.
DFAL issues information and materials in English and may also issue information and materials in certain other languages. The recipient’s continued acceptance of information and materials from DFAL will constitute the recipient’s consent to be provided with such information and materials, where relevant, in more than one language.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
JAPAN
Provided for institutional investors only. This document is deemed to be issued by Dimensional Japan Ltd., which is regulated by the Financial Services Agency of Japan and is registered as a Financial Instruments Firm conducting Investment Management Business and Investment Advisory and Agency Business. This material is solely for informational purposes only and shall not constitute an offer to sell or the solicitation to buy securities or enter into investment advisory contracts. The material in this article and any content contained herein may not be reproduced, copied, modified, transferred, disclosed, or used in any way not expressly permitted by Dimensional Japan Ltd. in writing. All expressions of opinion are subject to change without notice.
Dimensional Japan Ltd.
Director of Kanto Local Finance Bureau (FIBO) No. 2683
Membership: Japan Investment Advisers Association
FOR PROFESSIONAL INVESTORS IN HONG KONG.
This material is deemed to be issued by Dimensional Hong Kong Limited (CE No. BJE760) (“Dimensional Hong Kong”), which is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
This material should only be provided to “professional investors” (as defined in the Securities and Futures Ordinance [Chapter 571 of the Laws of Hong Kong] and its subsidiary legislation) and is not for use with the public. This material is not directed to any person in any jurisdiction where (by reason of that person’s nationality, residence, or otherwise) the publication or availability of this material are prohibited or which would subject Dimensional Hong Kong (including its affiliates) or any of Dimensional Hong Kong’s products or services to any registration, licensing, or other such legal requirements within such jurisdiction or country. When provided to prospective investors, this material forms part of, and must be provided together with, applicable fund offering materials. This material must not be provided to prospective investors on a standalone basis. Before acting on any information in this material, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice.
Unauthorized copying, reproducing, duplicating, or transmitting of this material are prohibited. This material and the distribution of this material are not intended to constitute and do not constitute an offer or an invitation to offer to the Hong Kong public to acquire, dispose of, subscribe for, or underwrite any securities, structured products, or related financial products or instruments nor investment advice thereto. Any opinions and views expressed herein are subject to change. Neither Dimensional Hong Kong nor its affiliates shall be responsible or held responsible for any content prepared by financial advisors. Financial advisors in Hong Kong shall not actively market the services of Dimensional Hong Kong or its affiliates to the Hong Kong public.
SINGAPORE
This material is deemed to be issued by Dimensional Fund Advisors Pte. Ltd., which is regulated by the Monetary Authority of Singapore and holds a capital markets services license for fund management.
This advertisement has not been reviewed by the Monetary Authority of Singapore. This information should not be considered investment advice or an offer of any security for sale. All information is given in good faith without any warranty and is not intended to provide professional, investment, or any other type of advice or recommendation and does not take into account the particular investment objectives, financial situation, or needs of individual recipients. Before acting on any information in this material, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice. Dimensional Fund Advisors Pte. Ltd. does not accept any responsibility and cannot be held liable for any person’s use of or reliance on the information and opinions contained herein. Neither Dimensional Fund Advisors Pte. Ltd. nor its affiliates shall be responsible or held responsible for any content prepared by financial advisors.
10/19/2021
https://my.dimensional.com/finding-your-balance-tradeoffs-and-decisions-in-portfolio-rebalancing
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