Saturday, May 5, 2012

On Rebalancing

Some recent research on rebalancing:  There's a tradeoff between staying true to the desired asset allocation -- versus: execution costs (commission and slippage), and normal market action (fluctuations, trends).

Rebalancing too frequently can create extra costs. On the other hand, rebalancing infrequently allows the asset mix to drift -- and can increase risk (nominal risk and risk relative to the desired mix). Based on other publications -- as well as Monte Carlo simulations I performed -- the data DOES show that rebalancing too frequently can give up some gains in exchange for potential expected asset mix drift. This is evidence of how markets can trend -- and yield excess performance for holding assets that are trending... (But some of these topics might be the topic of other research/articles)... The "sweet spot" for rebalancing seems to be 6-14 months, depending on the assets/investment vehicles -- and investment goals.

Interestingly, some products (like commodity indices) are designed to rebalance annually rather than monthly (or even daily)...

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