A portfolio's asset allocation reflects an investor's goals and temperament—the need for return and ability to withstand the financial markets' inevitable turbulence. Over time, as the returns of higher- and lower-risk assets diverge, a portfolio can take on exposures that are inconsistent with the investor's risk and return objectives. Rebalancing from one asset class to another can put the portfolio back on track.
We review the benefits of rebalancing, analyze the impact of different rebalancing frequencies and thresholds, and highlight strategies to minimize rebalancing costs. Our analysis suggests three best practices when setting expectations for and executing a rebalancing strategy: Rebalance to manage risk and emotion. Set a rebalancing "trigger." Minimize the transaction and tax costs of rebalancing.
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