Practical Considerations in Rebalancing
Rebalancing is a multifaceted concept. Among other rebalancing decisions, investors can rebalance at the major asset class level (cash, fixed income, equity, and real assets), the sub-asset class level, or even the manager level. Additionally, investors can rebalance on a set calendar schedule or do so only when an asset class drifts by a predetermined level from its target.
Before stepping into the markets to rebalance a portfolio, investors should always consider if their situation has changed and whether their investment policy statement (IPS) reflects their current circumstances. It is not uncommon for a client’s risk tolerance to increase over time as her wealth compounds in excess of her spending needs. In these cases, a portfolio with a higher equity allocation may be appropriate, and the investor may be able to amend her IPS from the original allocation to specify her desire for a portfolio with a different target asset allocation.
As an example, consider a client that has grown her assets from $10 million to $20 million in 10 years and, as a result, has an equity portfolio weight that has drifted above original targets. If this client has had only minimal increases in the amount of spending expected from her portfolio, then she may have an increased ability to accept risk, and it could be appropriate to consider changing the portfolio’s target asset allocation to include a higher equity target and not rebalance.