A portfolio should not be invested in an asset allocation strategy and then forgotten. Each portfolio must be rebalanced to keep the asset classes aligned with the long-term asset allocation strategy. Rebalancing reduces risk, invests cash effectively and keeps a portfolio on track. A disciplined rebalancing program also eliminates subjective and emotional decision making that can throw a portfolio far off an investor’s desired level of risk.
An ongoing rebalancing program is rigorously applied at Portfolio Solutions®. We review all portfolios continuously and single out client portfolios where asset classes are off the target allocation by a meaningful amount. As an example, assume a portfolio is being managed to a 50 percent equity and 50 percent bond allocation. It will be a candidate for rebalancing if the equity or bond portion grows to 55 percent or falls to 45 percent. The figure below illustrates this example.
Portfolio rebalancing is not automatic. Although our computer programs isolate client portfolios that need review, each review is individually conducted by our highly trained portfolio management staff that makes the ultimate rebalancing decisions. There are reasons a portfolio may not be rebalanced at the time it is identified. Expected cash flows, trading cost minimization and tax efficiency play important roles in rebalancing decisions.
Rebalancing will occur when a meaningful contribution of cash and/or securities is made to an account or a cash withdrawal is requested by a client. It is important for clients to communicate with us when there will be a cash withdrawal from an account so that we may raise the cash in a proper time period. Many clients are on an automatic withdrawal program and those clients do not need to contact us at each withdrawal period.
Dividend and interest income may also be used for rebalancing. This income initially flows into a money market fund where it is either invested where needed or distributed out periodically as part of an automatic withdrawal program.