Rebalancing Investments - Rebalancing Bonus

Rebalancing Bonus

The promise of higher returns from rebalancing to a static asset allocation was introduced by William Bernstein in 1996. It has since been shown to only exist under certain situations that investors are not able to predict. At other times rebalancing can reduce returns. Most agree that:

• A potential rebalancing bonus is determined by two assets' relative variances and covariance. These metrics are developed by averaging historical returns, which are no guarantee of future results in the short term or long term. E.g. debt is traditionally thought to be negatively correlated to equities, but during the 'Great Moderation' they were positively correlated.
• The bonus would be maximized by a 50:50 weighting between the two assets. But that is not to say any particular portfolio should have that weighting.
• The bonus is greater when each asset's price swings widely, so that each rebalancing creates an entry point at a very low cost relative to the trend. But that is not to say price volatility is a desirable attribute of any asset.
• The bonus is greater when the prices of both assets are increasing at roughly the same trend rate of return. If one asset's growth is much lower, each rebalancing would push money from the winning asset into the losing (or lesser return) asset.
• The bonus is greater when returns are negatively correlated and revert to their mean on the same cycle as the rebalancing takes place.

The Constant-Mix rebalancing strategy will outperform all other strategies in oscillating markets. The Buy-and-Hold rebalancing strategy will outperform in up-trending markets.