Key Points

  • Systematic rebalancing raises the likelihood of improving long-term risk-adjusted investment returns.
  • The benefits of rebalancing result from opportunistically capitalizing on human behavioral tendencies and long-horizon mean reversion in asset class prices.
  • Investors who “institutionalize contrarian investment behavior” by relying on a systematic rebalancing approach increase their odds of reaping the reward of rebalancing.


Introduction
Embracing a disciplined approach to rebalancing can lead to better long-term investment outcomes. Overcoming the natural tendency to wait-and-see before repositioning our portfolios can be a difficult, but worthy, goal for investors to pursue. Advisors can help investors surmount this and other behavioral hurdles by adopting a systematic rebalancing approach that effectively institutionalizes contrarian investment behavior.

This is the eighth and last article in a series that focuses on the investment role of financial advisors. Previously, we have discussed the major contributors to successfully meeting the long-term financial goals of investors: starting yield, risk, diversification, manager selection, portfolio construction, performance measurement, and taxes.

According to a recent Wells Fargo/Gallup Survey,1 31% of investors would opt to spend an hour stuck in traffic rather than spend that time rebalancing their portfolios. Why would we subject ourselves to gridlock instead of performing a simple task such as rebalancing a portfolio? With our office near Los Angeles, the most congested city in the world,2 we are certainly no strangers to traffic, so we will venture a guess.

It may well be that for many investors, rebalancing feels worse than rush hour. When we're stuck in traffic, at the very least we’re in the comfort of our cars and can find other productive ways to pass the time, such as listening to the radio, podcasts, or audiobooks. In contrast, rebalancing forces us to endure the discomfort of buying assets that have just inflicted pain from underperformance and of selling recent winning assets.3 Even worse, rebalancing our portfolios may induce additional pain if momentum carries prices further from fair value. On the highway, our GPS provides helpful estimates of our arrival time, but no GPS is available to pinpoint when market cycles will end: fair value may take months, years, and sometimes even decades to assert itself.

But if we broaden our perspective beyond the salience of the here-and-now to focus on what will ensure our long-term physical and financial well-being, the picture flips. Over time, traffic congestion inadvertently leads to damaging effects on our wallets, health, and environment.4 In contrast, a disciplined rebalancing approach continually positions our portfolios to reduce risk, raising the likelihood of our being able to improve risk-adjusted returns over those of an asset mix whose weights drift with price movements. In short, consistent rebalancing is a reliable, and often underappreciated, source of higher risk-adjusted performance for the patient investor.