Portfolio Rebalancing: 2 Approaches And A Practical Example

I recently wrote an article on the topic of portfolio rebalancing that was selected as an Editors' Pick On Seeking Alpha.

Here is an excerpt from the article:

. . . Much like the landscape around your home, your asset allocation needs regular maintenance. When you landscaped your home (or started a garden, as the case may be), you likely worked with design and installation professionals to pick exactly the right plants for each location depending on your climate zone, the correct sun/shade mix and similar factors. No doubt, it all looked absolutely spectacular upon completion. However, left untended, your landscape or garden will not look nearly as good even weeks later, not to mention a year or more. In fact, it might ultimately look so bad that it would be hard for an impartial observer to discern that there had ever been a design or plan.

People with a scientific mind call this entropy, one definition of which is "a gradual decline into disorder." Your asset allocation, left untended, is also subject to entropy. 

Another way to phrase this is "portfolio drift." Fundamentally, this is not a bad thing. Likely, you purposely designed your portfolio such that it was diversified, which typically means it contains asset classes with low correlation; where one may outperform at the same time another underperforms. Over time, however, this behavior can result in your asset classes drifting far from their initial weighting. In turn, this has the potential to raise the risk level of your portfolio far beyond what you ever intended.

If you find that excerpt intriguing, here is a link to the rest of the article.