Custom rebalancing is a method that helps you manage your investments by keeping them aligned with your original goals, like a 60% stocks and 40% bonds allocation. Without rebalancing, market changes can shift your portfolio, increasing risk. For example, a 60/40 portfolio from 1989 could have turned into 80% stocks by 2021 if left unchecked. The key takeaway? Rebalancing isn’t about increasing returns – it’s about managing risk and maintaining your investment strategy.

Here’s what you need to know:

• Types of Rebalancing:
  1. Calendar-based: Adjusts at fixed intervals (e.g., yearly). Simple but may miss market shifts.
  2. Threshold-based: Adjusts when an asset drifts beyond a set percentage (e.g., ±5%). More responsive but requires frequent monitoring.
  3. Custom/Hybrid: Combines time and threshold rules for better balance and flexibility.
• Why It Matters:
  • Keeps your risk level consistent.
  • Prevents one asset from dominating your portfolio.
  • Enforces disciplined investing (buy low, sell high).
• Impact on Returns:
  Rebalancing doesn’t drastically boost returns but stabilises risk. For instance, a rebalanced portfolio during a downturn had a 5.1% smaller loss compared to one left unmanaged.
• Best Practices:
  Use a ±5% tolerance band for adjustments. Review monthly or quarterly, but only trade when necessary to reduce costs.

Custom rebalancing is especially useful for smaller portfolios, as it can lower risks without incurring high transaction costs. It’s about sticking to a consistent, rules-based process to keep your investments on track.

Research Findings on Long-Term Returns

Rebalancing vs Buy-and-Hold Approaches

A 20-year study covering the period from 1983 to 2012 revealed that rebalancing strategies, even when incorporating custom thresholds, barely outperformed the buy-and-hold approach. The difference? A modest 11 basis points in returns.

But here’s the thing: the real value of rebalancing isn’t in boosting returns – it’s in managing risk. For example, a Vanguard study that examined portfolios from 1926 to 2009 found that skipping rebalancing led to increased portfolio volatility, jumping from 12.1% to 14.4%. Moreover, buy-and-hold portfolios often experience negative skewness, meaning they are more prone to significant losses during market downturns. As Professor Ajit Dayanandan put it:

“The gains from portfolio rebalancing are insignificant. The hype associated with such strategies does not withstand the test of data in the long run”.

While the absolute returns of rebalancing strategies may not dazzle, they tend to shine when measured by risk-adjusted metrics like the Sharpe ratio. The bottom line? Rebalancing is best viewed as a tool to keep your portfolio aligned with its intended asset allocation, not as a method to supercharge returns.

With this understanding of rebalancing as a risk management strategy, let’s explore how custom approaches can benefit smaller portfolios.

Performance of Smaller Portfolios with Custom Rebalancing

For smaller portfolios, the risk management advantages of rebalancing become even more noticeable, especially when tailored strategies are applied. Unlike large institutional funds – which are estimated to lose about S$21.6 billion annually due to front-running from predictable rebalancing schedules – individual investors can adjust their portfolios without causing market disruptions.

One effective method for smaller portfolios is cash flow rebalancing. Instead of selling assets and triggering capital gains taxes, this approach uses new contributions, dividends, or interest payments to fine-tune allocations. This method captures most of the risk-control benefits without the extra effort or costs of more intensive strategies.

For portfolios with a mix of asset classes, the 5/25 rule offers a practical framework. It suggests rebalancing stock picks when they deviate by 5% from their target allocation and adjusting smaller holdings (those making up 10% or less of the portfolio) only when they stray by 25%. This strategy helps avoid unnecessary trades and keeps transaction costs in check.

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Rebalancing Your Portfolio: When’s the BEST Time?

Comparison of Rebalancing Methods

Let’s dive deeper into the different rebalancing approaches and how they stack up in terms of costs, responsiveness, and complexity. The three main methods – calendar-based, threshold-based, and custom (or hybrid) strategies – each come with their own pros and cons.

Calendar-based rebalancing is the easiest to execute. You simply pick a date – whether monthly, quarterly, or annually – review your portfolio, and make the necessary adjustments. But this simplicity has its downsides. For example, research on a US 60/40 portfolio shows that quarterly rebalancing results in about twice the turnover compared to annual rebalancing. Additionally, because the timing is predictable, it can leave your portfolio vulnerable to front-running.

Threshold-based rebalancing, on the other hand, works by triggering trades whenever an asset drifts beyond a set range, like ±5%. This makes it more responsive to market changes and often more efficient than sticking to fixed dates. As Xing Hong, PhD, Senior Researcher at Dimensional, puts it:

“Rebalancing approaches that deviate from calendar-based trading and instead base rebalancing decisions on portfolio composition may produce better tradeoffs for investors”.

In fact, research shows that monthly and quarterly rebalancing can lead to 200% to 400% more portfolio turnover than annual or threshold-based methods, without offering significant advantages in keeping target weights. This is where custom methods come into play, blending the strengths of calendar and threshold strategies.

Hybrid approaches combine the best of both worlds. For example, institutional investors often conduct an annual review while using tolerance bands (±10–20%) to address significant deviations. Historical data from 1926 to 2003 suggests that patient, deliberate policies often outperform reactive strategies in terms of risk-adjusted returns.

Here’s a quick breakdown of how these methods compare:

Each method has its place, depending on your portfolio’s needs and your investment goals. While calendar-based strategies offer simplicity, threshold and hybrid approaches offer more tailored solutions to balance costs and risk.

Impact of Custom Rebalancing on Risk and Diversification

Risk Management Through Custom Rebalancing

Custom rebalancing offers a more precise way to manage your portfolio’s risk by limiting how far it can drift from its target allocation. In contrast, calendar-based methods leave the extent of this drift uncertain between rebalancing dates. For instance, without rebalancing, a typical 60/40 stock-bond portfolio can shift to an average equity allocation of over 84% over time, significantly altering its original risk profile.

Consider this example: during a market downturn, a portfolio rebalanced quarterly suffered a 20.8% drawdown, while one that was never rebalanced experienced a steeper 25.9% loss. That’s a 5.1 percentage point difference, highlighting the protective edge of rebalancing during turbulent periods. Custom strategies, such as rebalancing when an asset drifts beyond a ±5% tolerance band, provide tighter control over portfolio drift compared to rigid calendar-based schedules.

Adopting a systematic trading approach like patient rebalancing – using longer intervals or wider thresholds – can further reduce risk by avoiding trades triggered by short-term market noise. Instead, it allows time for long-term trends to stabilise. Research shows that during periods of restrictive monetary policy, rebalancing more frequently than every 10 to 20 months tends to be less effective. David M. Smith from the State University of New York at Albany explains:

“Patient rebalancing policies tend to dominate quick-trigger policies, even before trading costs and taxes are considered”.

This method not only mitigates risk but also helps maintain critical portfolio diversification.

Diversification Benefits of Customised Frequencies

Custom rebalancing doesn’t just manage risk – it also strengthens diversification by curbing the overaccumulation of high-performing assets. By keeping the portfolio balanced, it prevents overconcentration in certain areas. This is vital because rebalancing adjusts the distribution of terminal wealth, narrowing the range of outcomes and reducing extreme positive skewness, which helps safeguard against worst-case scenarios.

Compared to calendar-based methods, custom tolerance bands are generally more efficient, achieving lower turnover for the same level of tracking error. For portfolios with lower asset correlations or higher volatility, more frequent monitoring is essential to prevent significant risk drift. Asymmetric tolerance bands, such as +7%/–3%, can also address specific risks effectively, like maintaining a pro-growth stance in markets where bull trends tend to outlast bear phases.

Beyond short-term risk management, custom rebalancing enhances diversification by focusing on risk allocation. Strategies that rebalance based on risk rather than capital weights can reduce risk variability by 37% to 65% across different asset classes. For investors managing broadly diversified portfolios, annual or semi-annual reviews with a 5% tolerance threshold strike a good balance between risk control and cost efficiency.

Practical Findings from Empirical Studies

Evidence from Historical Data and Simulations

Long-term research spanning January 1979 to December 2019 reveals that rebalancing a US 60/40 portfolio quarterly, rather than annually, doubles portfolio turnover but cuts tracking deviation in half. This discovery highlights how rebalancing frequency can shape portfolio performance and sets the stage for evaluating custom rebalancing strategies across various markets.

Studies of portfolios in the US, UK, and Germany consistently show that rebalancing strategies – whether periodic, threshold-based, or range-based – outperform the traditional buy-and-hold approach when measured by metrics like Sharpe ratios, Sortino ratios, and Omega measures. Researchers Hubert Dichtl, Wolfgang Drobetz, and Martin Wambach emphasised:

“All rebalancing strategies outperform a buy-and-hold strategy in terms of Sharpe ratios, Sortino ratios, and Omega measures. The differences… are not only statistically significant, but also economically relevant”.

Adding to this, a study by Newfound Research uncovered that the choice of rebalancing schedule could lead to a return difference of over 40% in a single calendar year for a strategy replicating the S&P Enhanced Value index. This highlights the importance of using custom tolerance triggers to maintain targeted asset allocations, a crucial aspect of risk management.

These findings offer clear, actionable insights for investors looking to refine their strategies.

Key Takeaways for Traders and Investors

For Singapore-based traders, these findings point to several practical steps. First, consider tolerance bands over calendar-based rebalancing. Research shows that a symmetric band of ±5% is more efficient, achieving lower tracking error without increasing turnover. Second, adopt a “monitor but wait” approach: review your portfolio monthly or quarterly but only make adjustments when your custom triggers are breached.

As Xing Hong, PhD, explains:

“Rebalancing approaches that deviate from calendar-based trading and instead base rebalancing decisions on portfolio composition may produce better tradeoffs for investors”.

Finally, prioritise investment platforms with zero switching costs for mutual funds or unit trusts. This ensures you can stick to a disciplined rebalancing strategy without sacrificing returns. Remember, the goal of rebalancing is to manage risk effectively – not to chase returns.

Conclusion

Using tolerance bands for custom rebalancing offers better risk management compared to sticking with fixed calendar schedules or allowing portfolio drift. While rebalancing doesn’t boost returns, it plays a crucial role in maintaining your portfolio’s intended risk profile. As Sellwood Consulting aptly states:

“Rebalancing is fundamentally a risk management tool, not a return enhancement tool”.

For investors in Singapore, setting tolerance bands of around ±5% to ±10% from your target allocations is a practical approach. Checking your portfolio monthly or quarterly helps reduce unnecessary turnover, balancing short-term momentum with lower transaction costs. This steady approach ensures your portfolio remains aligned with your investment goals over time.

Drawing from the research and strategies discussed earlier, rebalancing is all about discipline and overcoming behavioral biases. The key isn’t about choosing the “perfect” method but committing to a consistent, rules-based process. Whether you prefer regular calendar reviews or threshold-based adjustments, sticking to a structured plan ensures your portfolio stays on track with your long-term objectives.

For more insights on systematic trading and portfolio management, check out Collin Seow Trading Academy.

FAQs

What makes custom rebalancing different from calendar or threshold rebalancing?

Custom rebalancing is all about designing a personalised approach to adjust your portfolio. Instead of sticking to fixed schedules like calendar rebalancing (monthly or yearly) or waiting for asset weights to shift beyond a set limit as in threshold rebalancing, this method lets you fine-tune based on your own rules or your portfolio’s actual allocation.

This tailored approach helps align your investments with your financial goals, risk tolerance, and the current market environment. It can also help you maintain a balanced risk level while potentially boosting your portfolio’s performance over time.

Why doesn’t rebalancing have a big impact on portfolio returns?

Rebalancing usually doesn’t lead to a noticeable increase in portfolio returns. Why? Because any potential profits from buying low and selling high often get eaten up by transaction costs, taxes, and the need to sell assets that may be performing well. While it’s a useful strategy for keeping your risk levels in check, its direct impact on boosting returns tends to be quite limited.

Rather than seeing rebalancing as a way to chase returns, it’s more helpful to think of it as a way to manage risk and keep your portfolio aligned with your long-term investment objectives.

What are the advantages of using tolerance bands for custom portfolio rebalancing?

Using tolerance bands for custom rebalancing can be a smart way to manage your investments. Instead of making constant adjustments, rebalancing happens only when an asset’s value moves beyond a set range. This keeps your portfolio on track with your long-term financial goals while avoiding unnecessary trades.

One key advantage is the reduction in transaction costs, as fewer trades mean lower fees. Another benefit is that it gives assets more time to grow before rebalancing, potentially boosting the portfolio’s overall performance. By focusing on meaningful changes, tolerance bands offer a practical mix of discipline and flexibility, helping to manage risk while aiming for better returns.