Rebalancing is an essential part of managing a portfolio, ensuring that investments stay aligned with your clients' goals and risk tolerance. While most advisors are familiar with strategies like time-based or threshold rebalancing, there’s another effective method worth considering: setting percentage-based upper and lower limits on allocations combined with time-based rebalancing. This approach adds structure, flexibility, and discipline to portfolio management—all while reducing unnecessary trades.
What Are Percentage-Based Allocation Limits?
Think of these limits as guardrails for your clients’ portfolios. Each investment or asset class gets a target allocation and a "zone of comfort" defined by upper and lower percentage limits. For instance:
Target Allocation: 10%
Upper Limit: 12% (+20%)
Lower Limit: 8% (-20%)
As long as the investment stays between 8% and 12% of the portfolio, there’s no need to rebalance. However, if it strays outside that range during a periodic review (e.g., quarterly or annually), you take action to bring it back into alignment.
This method avoids the pitfalls of constant tinkering or overtrading while maintaining portfolio integrity.
Why Use Limits with time-based rebalancing?
Combining percentage-based limits with scheduled rebalancing creates a disciplined, efficient process for rebalancing. Here’s why it works so well:
Cost Control
Frequent trading leads to higher transaction fees and tax consequences. By rebalancing only when allocations breach their bands, you reduce unnecessary trades and their associated costs.Improved Risk Management
Staying within pre-defined ranges helps maintain the portfolio's desired risk profile, even during periods of market volatility.Behavioral Benefits
This structured approach minimizes emotional decision-making, encouraging clients to stick to their investment plan instead of reacting to short-term market noise.
The Evidence: Real Returns from Rebalancing Bands
Research supports the effectiveness of this strategy. A study in the Journal of Financial Planning found that portfolios using rebalancing bands with periodic reviews outperformed those rebalanced on a fixed schedule. Specifically, portfolios with 10% bands saw an average annualized return boost of 0.40% compared to time-only strategies. That extra performance adds up significantly over time, especially in long-term portfolios.
Michael Kitces also explored this approach, noting that combining allocation bands with periodic reviews improves risk-adjusted returns. His research showed that portfolios using a 20% band captured market trends while minimizing unnecessary trades, offering both higher returns and reduced volatility.
How to Implement This Strategy
Define Your Allocations
Set clear target percentages for each asset class based on your client’s goals and risk tolerance.Establish Limits
Decide on the acceptable range for each allocation. For example, a 10% allocation might have a range of 8–12%.Rebalance/Reconstitute According to Your Portfolio
Stay true to your portfolio's designated rebalancing and reconstitution schedule.
A Balanced, Smarter Approach
Rebalancing doesn’t have to mean rigid schedules or constant changes. By using percentage-based limits in conjunction with time-based rebalancing, you create a system that’s both flexible and disciplined. The research is clear: this method not only helps manage risk but also enhances long-term returns.
For investment advisors, this is a practical strategy that keeps clients’ portfolios on track while minimizing costs and maximizing efficiency. If you’re ready to make rebalancing simpler, smarter, and more effective, setting upper and lower limits might just be the solution you’re looking for.