When running a diversified portfolio with a number of assets and asset classes, one key aspect is at what time should you rebalance the portfolio?
Most retail investors find it sufficient to log onto their investment accounts on an annual basis, say near the end of the year, to make sure the instrument weights are decent.
More experience investors (and professinals funds) usually have more of a periodical rebalancing approach, e.g. quarterly.
Additionally, you could work with bands, which means that if an asset has drifted 5% from its target weight, it is time to rebalance.
The importance of rebalancing is that you want to avoid drifting of assets, as it would lead to situations where your portfolio over times become overly concentrated.
When managing an All-Seasons Portfolio especially, recurring rebalancings becomes even more important, as you would otherwise lose the risk parity benefits. You would no longer have the right balance in the portfolio to each economic regime.
On the flip side, though, rebalancing too soon means that you potentially give away potential gains. If one asset in your portfolio is thriving and in a clear upward going trend, rebalancing too soon will mean that you forsake some returns. The opposite is also true – you don’t want to buy an asset with a clear negative trend, as you would just pile into a loss-making machine.
What this all means is that you need to find balance in your rebalancing strategy.
This is something we will be exploring with this article, namely how to implement a strategic rebalancing approach in your portfolio. Such an approach would live side-by-side with your recurring (calender-specified) rebalancings, and potentially enhance the total return profile of your portfolio be improving rebalancing timings (and how much you rebalance).
About Strategic Rebalancing
Before we jump to discussing 3 key rebalancing methods you could implement in your portfolio further down, we’ll start with some brief background.
While most just rebalance mechanically back to the original asset weights, we will be looking at whether rebalancing can be carried out in a way that improves returns and minimizes drawdowns when compared to both buy-and-hold strategies, as well as periodical rebalancing.
My inspiration for this post came from a chapter in the book Strategic Risk Management written by principals in Man Group – an investment management firm founded in 1783 and headquartered in London with USD 140bn assets under management.
In addition to discussing strategic rebalancing, the authors portray several layers of risk management that are designed to improve overall performance.
As stated in the intro, many investors – both retail investors investing their personal wealth, and asset managers with millions in AUM – usually employ calendar-based rebalancing of a portfolio. This could be the quarterly rebalancing of a mutual fund, or that the retail investor sits down annually for a few hours during the Christmas holidays ahead of the new year to rebalance the portfolio.
Such periodical rebalancing is built on the foundation of mean reversion. It essentially sells the winners of the past period, and buys the losers. Over time, this is from where a rebalancing premium is captured when your portfolio consists of several uncorrelated assets. All-Seasons Portfolios are a typical such portfolio that benefits from the rebalancing premium.
However, Man Group has researched strategic rebalancing techniques that could mitigate drawdowns through more bespoke methods for rebalancing. Their discussed techniques cover both the periodical rebalancings, as well as mid-period rebalancing when assets’ weights in portfolios deviate by more than a predetermined amount (rebalancing spans).
The chapter in the book that covers strategic rebalancing, is to a vast extent based on an article the authors published in June 2020 in the Journal of Portfolio Management. There it is discussed how a mechanical rebalancing strategy, for example when you rebalance a portfolio monthly, quarterly, or annually, this can lead to substantially larger drawdowns in times of crises when markets often are trending.
In such an environment, when trend is an important factor, by selling an asset that is trending upwards (for example bonds or gold during a crisis) and buying an asset in a negative trend, will exacerbate the portfolio drawdown, as you would be allocating more capital to asset classes that are likely to continue to decline, and taking away from assets that are likely to outperform.
To illustrate this phenomenon, the authors show the difference in return of a 60/40 portfolio through the 2008 GFC, with the only difference being the rebalancing strategy.
By rebalancing against a trend, the total portfolio drawdown was worsened by about 5 percentage points, when compared to a buy-and hold strategy (no rebalancing), even though the portfolio caught up a year later (do not underestimate the psychological effects of a deeper drawdown).
Even though this phenomenon becomes particularly distinctive during times of crises, the same effect is at play also in connection to periodical rebalancing. Despite trend being a weaker factor during non-crisis regimes, it will remain as one of the components driving price developments for an asset.
The retail investor should therefore consider the implications of trend and momentum both for periodical rebalancing and ad hoc rebalancing when using rebalancing spans, and implement a strategic rebalancing approach to further improve risk-adjusted return by minimizing drawdowns and thus the overall portfolio volatility, and potentially capture additional percentage points of return from trend.
Let us continue with looking at a few ways of implementing this in your portfolio. I will also especially highlight the ways I have taken strategic rebalancing to heart in my All-Seasons Portfolio, which I trade on eToro (which you can copy with ease).
Why should you rebalance your portfolio?
Rebalancing is an important part of risk parity investing. Over time, asset returns are mean reverting, with the result that through rebalancing, you can achieve better risk-adjusted return by selling an asset at a high and buying at a low.
Additionally, by investing in several uncorrelated assets, you will also be gaining a rebalancing premium on top of each asset’s risk premium. I have several times linked to this paper by ReSolve Asset Management which clearly explains this concept. In short, you would be selling an asset at a relative high, and at the same time buying another at a relative low; and as both are likely to revert to their respective means, your returns will be better than a buy-and-hold strategy. Therefore, through methodical rebalancing and implementing rules for it as a key component of an investment strategy, you will see shallower drawdowns and more consistent positive return.
However, as mentioned, rebalancing can at times cause negative effects on your returns, especially when the markets are trending. This is why it is wise to consider a slightly different approach to rebalancing than the mechanical method of going back to the starting allocation every month, quarter or year.
Trend is an important part of returns
Trend and momentum are an interesting anomaly in markets, as they should not really be existing according to economic theory. But, thanks to investment psychology, they do have a measurable impact on asset returns in the short to intermediate term.
Even though trend can be found in several corners of the market and in individual assets during normal times (when no crisis is ongoing), trends become obvious during a crisis, when sell-offs foster further sell-offs, and in the subsequent recovery, risk-on fosters more risk-on behavior.
1. Adding a trend-following strategy
The first proposed way of capturing trend in a rebalancing strategy is through adding a trend strategy allocation on top of the existing portfolio.
Bear with me, as this is the most technical of the three approaches Man Group discusses.
How this is achieved in practice is that you would let your original portfolio take up 90% of the portfolio including the trend-following strategy, and the trend-following strategy takes up the remaining 10%. Hence, you would just scale back all holdings by 10%, so a stock holding would become 27% (from 30%) and a long-term government bonds holding would become 36% (10% down from 40%), etc.
For the trend-following strategy, this could be built in a variety of ways, with different look-back periods for determining trends (1m, 3m and 12m used by the article authors) and different ways of defining trend signals, or a combination of many such signals in a ranking system. Without going into any particular detail,
In all three cases analyzed by the Man Group (page 10 of the article), by applying a trend-following strategy, the Return/Volatility ratio for the 60/40 portfolios used for illustrative purposes increased from 0.92 to a range of 1.01-1.04 depending on lookback period for determining trends (with 1m and 12m being the best performers, both with Return/Volatility ratios at 1.04 and 1.02 respectively).
The aim is that you would have your core portfolio in the bottom (90% of the portfolio) and the last allocation is determined to what happens to be most in trend at any given time. Hence, automatically, you would be scaling up positions in a positive trend, and be allocating less to an asset whose prices are likely to deteriorate, which will mainly benefit returns through decreasing drawdowns.
While the strategy could be effective, as shown by the authors at Man Group, it will require a much more active approach to portfolio management than what a retail investor would be able to, or willing to, implement on any sustained horizon.
Perhaps alternative approaches to implement a trend-following element to investing would be more feasible. Let’s continue by looking at two ways that would make more sense to retail investors, and which I have started using for my portfolio.
2. Smart rebalancing timing based on trend signals
The second rebalancing strategy proposed by the authors is smart rebalancing timing, which is much easier to implement for retail investors. This means that you would have your portfolio as it is (not split between different strategies) and only proceed with the rebalancing, be it a periodical one or an ad hoc one, when the trend signals tells you to.
For example, let us say that you are about to rebalancing your portfolio toward the year-end. But, you also not that stocks are in a weak trend right now, and that if you proceed with the rebalancing and buying more stocks, you would be buying against the trend.
An easy way of implementing is to track simple moving averages (MA50 and MA200), which shows the average price of an asset over the last roughly 3 months and 12 months. If an asset is currently trading above these two values, it can be said that the asset is in a positive trend (especially if the MA50 > MA200).
For as long as the asset can be deemed to be in a positive trend, you either wait with rebalancing, or only rebalance partially (see the 3rd method below) before the trend signal is no longer active. Conversly, you wait with buying assets that remain in a negative trend.
Intuitively, drawdowns would be reduced, and risk-adjusted portfolio returns should increase slightly by implementing this simple trick.
This is a way easier and more retail investor-friendly way to implement trend as a component in your portfolio rebalancing strategy, without the hassle of running two different strategies in parallel. As shown by the authors at Man Group, you would be more likely to make your drawdowns shallower by avoiding selling assets in the middle of a rising trend, and buying assets in the middle of a negative trend.
3. Partial rebalancing
The third method is partial rebalancing. This is a rebalancing strategy that is the easiest of all to implement, as you do not have to spend additional time or tracking assets’ momentum in depth. Instead, this easy to use rebalancing strategy will make you automatically catch any trends without the need for more input.
What you would do with partial rebalancing is that when it is time for your planned rebalancing, regardless if it is a periodical one or an ad hoc rebalancing triggered by weight deviation intervals, is that you would not rebalance all the way back to original allocation.
Instead, you would be capturing the trend to a “good enough” extent by rebalancing only a part of the distance back to aimed allocation. For example, if your aimed stock allocation is 30% of your portfolio weight, and that the actual allocation has grown to 36% since the last rebalancing, you would not rebalance it all the way back to 30%.
Rather, to capture a bit more of a potential ongoing trend, you would rebalance the holding back by a predetermined factor, for example 50% of the. Hence, using this strategy, when rebalancing the stock allocation in this example, you would scale it from 36% to 33%, being halfway of the distance from the aimed allocation (0.5 * 6% = 3%).
This is a cheap way of capturing trends as you would maintain a dynamic risk allocation exposure to an asset class that has been in a positive trend relative to other asset classes (see my separate post explaining Dynamic Risk Allocation). This is logically the underlying case, as this asset class would not otherwise have been overweight in the portfolio.
There is a negative side to this strategy though, and that is blindness to whether a trend signal has gone away, which you would not be spotting. That is to say, if the asset has been overweight by 30% from target weight (an allocation of 39% using our previous stock example) but that this has now reduced to 20%, then staying overweight in an asset that could continue to decline, would not be the most efficient use of your capital.
While not perfect, this kind of partial rebalancing strategy is a decent compromise that gives you at least some upside from following on to trend. The study exhibited by the authors at Man Group, showed that while this strategy worked to some extent for reducing drawdowns, it was less potent than other rebalancing strategies used.
Note, however, that when it comes to ad hoc rebalancing, the perks of implementing partial rebalancing is much stronger than in the case of periodical rebalancing strategies. The reason is that when it becomes relevant to execute a rebalancing mid-period (between two periodical rebalancing dates), then by default, the asset has been trending, as it would otherwise not reach the end of a rebalancing span.
Hence in doing partial rebalancing mid-period, you would be taking home some profits from a relatively strong asset, while still leaving some money on the table to gain additional returns if the trend continues.
Optimal way of portfolio rebalancing for retail investors
There is no one right solution for anything in finance. You need to find a rebalancing rule which you can easily track and implement.
If you don’t fancy checking up on your investments on a near-daily basis to follow trend signals, then periodical (calendar-based) rebalancing (potentially combined with partial rebalancings) might suit you the best.
If you, however, don’t mind tracking your portfolio and have the tools for it, more advanced methods are available. Then you can combine periodical and ad hoc rebalancings with trend signals and/or partial rebalancing strategies.
How I treat rebalancings in my public eToro portfolio, for example, is a mix of periodical rebalancing, trend signals, and partial rebalancing.
My main tool is moving average trend signals which tell me when it is time to rebalance an asset on an ad hoc basis. When a trend breaks, it is time to act.
When an asset has drifted from its aimed weight and I risk portfolio concentration (breaking with the All-Seasons Portfolio idea), I use partial rebalancing toward the target weight, even if a trend is intact. I use partial rebalancing as well when there is a trend, but the signal is weaker.
For periodical rebalancing though, I use a mix of partial rebalancing and smart rebalancing timing. The most important factor here will be to follow trend signals. As periodical rebalancing doesn’t occur that often, it is not a burden to review trend ahead of the rebalancing date.
In more general terms, for most investors, it is sufficient to use periodical rebalancing, and in connection to a rebalancing date, review to what extent the assets or instruments are trending. If there is a trend aligned with the assets deviance from the target weight (positive trend for an asset you are overweight in), then a partial rebalancing may be advisable. If, however, there is no clear trend, or if the trend is in the opposite direction (negative trend for an overweight asset), then rebalancing all the way back to the original weight may be the best choice.
This is the simplest way of smartening up your rebalancing game, without over-complicating it.
Depending on what level of hands-on work you are willing to put in, you could make any adjustments from this, either by always doing partial rebalancing as the easiest approach, to adding more trend signal tracking and adding an additional layer of timing delays. You could even implement tactical bets, if you are so inclined. The authors of the article also indirectly proposes a combination of strategies, i.e. that during months when there is no clear signal, the portfolio is rebalanced halfway to its aimed mix (see page 15).
Concluding remarks
Mechanical rebalancing of a portfolio is a good way of taking advantage of mean reversion and capturing a rebalancing premium in a portfolio built with several uncorrelated assets. Especially for a portfolio built to withstand different market regimes determined by economic growth and inflation, rebalancing will help you to effortlessly buy low and sell high, which is the holy grail of investing.
But mechanical rebalancing also imposes challenges. By rebalancing on autopilot and without further consideration, you are likely to be rebalancing out of assets in a positive trend, and by into assets that are declining. This could, with some bad luck, worsen a drawdown, if you would be scaling back on an asset that would offset losses, and buy an asset that will continue to be losing you money. You are therefore at risk at giving up potential return.
By giving your rebalancing strategy a little bit more attention, and expanding on this part of your overall strategy, you could by implementing trend-following rules, reduce drawdowns, and hence slightly increase your risk-adjusted (and absolute) return.
Such strategies vary in form, and you could implement it in many different ways depending on how much time you are willing to invest in managing your portfolio. For most retail investors, the additional small gain might not be worth the time if you would be going for the most advanced trend-following strategies for rebalancing.
I also recommend that you read the discussed article, as it covers the topic in more depth than what I have briefly conveyed in this post. Check out the book as well (Strategic Risk Management), as it holds a larger set of ways to manage risk that should help you building a set of tools for improving your portfolio management skills.
You find the article here: https://www.man.com/maninstitute/strategic-rebalancing, the summary here: https://www.man.com/maninstitute/strategic-rebalancing-summary, and the book: Strategic Risk Management.
Follow My Work
I apply these principles in practice through my own long‑term portfolio, which I manage transparently on eToro as a Popular Investor.
If you want to explore how All‑Weather investing works in the real world, or follow a disciplined, rules‑based approach to long‑term investing, you can find me on eToro under the username AllSeasonsPort.
You can also find more in‑depth research and educational content on this site, where I regularly publish articles on macro investing, portfolio construction, and long‑term wealth building.
If you want to get started with an All-Seasons Portfolio strategy on your own, you can start by checking out my article about this: Getting Started with the All-Seasons Portfolio or by checking up on What an All-Weather Portfolio is.
This article is for educational purposes only and does not constitute financial advice.
