Annual Rebalancing: A Habit that Needs Breaking?

We don't bathe annually, so why rebalance once a year? Smartleaf co-founder Jerry Michael asks.

Reviewed by: Staff
Edited by: Ron Day

Jerry Michael, President and co-founder of Smartleaf, says annual portfolio rebalancing is a habit that needs to be broken. He talks with Wealth Management editor Jeff Benjamin.

Jeff Benjamin: Why don’t you like annual rebalancing? 

Jerry Michael: For the same reason I don’t like annual bathing. It’s not frequent enough. In my view, annual rebalancing no longer meets professional standards of care.  

JB: How do you keep client portfolios in balance?

JM: You look at portfolios every day to see if they would be improved through trading, where improved could mean tax-loss harvesting, risk reduction, tracking error reductions and/or compliance with constraints. 

JB: Does this lead to excess turnover? 

JM: No. Rebalancing requires that you consider tax and transactions costs and that you avoid churn. Reviewing portfolios daily does not imply trading portfolios daily.  It doesn’t even necessarily lead to higher turnover than annual rebalancing. But it might result in trading the same portfolio three times in a volatile month, like we saw in March 2020, and then not trading the same portfolio for six months. The standard is to trade portfolios whenever it is beneficial to do so. Trading by the calendar—whether once a year, once a quarter or once a month—is both trading too frequently and not frequently enough.  

Annual Rebalancing

JB: Why has the planning industry relied on annual rebalancing? 

JM: Because they lacked the tools to do anything else. Rebalancing was a largely manual task, and that limited what you could do economically. It’s the same reason many firms, even those rebalancing more than annually, still only do tax-loss harvesting at year end. They don’t have the tools to do better. As it is, loss harvesting is one of the easier forms of tax management. Many firms do little else and so conflate loss harvesting with tax management. They’re not the same. 

Contact Jeff Benjamin at [email protected] and find him on X: @BenjiWriter        

Advisor Views is a bi-weekly Q&A-style series that features voices from across the financial planning industry sharing insights on investment strategy and portfolio management as it relates to the current economic environment.

The format enables advisors to respond in their own words to specific questions designed to provide readers with practical tools and tactics that can be applied to managing client portfolios.