Portfolio Rebalancing: Tradeoffs and Decisions

Abstract

This paper identifies a clear tradeoff between tracking error — performance differences relative to a targeted asset allocation — and turnover—a proxy for rebalancing costs — that can help guide investors’ rebalancing choices. We find that calendar-based approaches, while convenient, tend to lead to less efficient rebalancing tradeoffs than rebalancing with tolerance bands. Further improvements can be gained with tiered approaches that apply different tolerance bands across and within asset classes. We do not find evidence that rebalancing choices can reliably increase expected returns. Finally, our study evaluates how rebalancing choices relate to asset allocation and how they may impact a portfolio’s maximum drawdowns and shorter-term return differences to the target allocation.