Calendar vs. Threshold Rebalancing: Which Strategy Helps Keep Your Portfolio on Track?
- Clay Reynolds
- 3 days ago
- 3 min read
Free Lunches
Bill Bengen, often cited as the founder of the 4% rule, has also coined what he calls the “Four Free Lunches for Retirement Withdrawal Plans”.
Before diving into a specific free lunch, he mentions, I think contextualizing what makes these strategies "free" is important, and what they are compared to in the first place. After all, if these lunches are free, they must be compared to some price point or cost.
Bill Bengen's four free lunches refer to the Efficient Market Hypothesis. The Efficient Market Hypothesis (EMH) is a financial theory that was developed in the 1960s and 70s. This theory states that asset prices always incorporate all available information. There are three different forms of this theory (weak, semi-strong, and strong). Still, the important thing this theory drives home is the following: No investor can consistently achieve returns above the market average without taking on additional risk.
Through his four free lunches, Bengen lists four ways to improve portfolio performance or reduce risk without requiring the investor to take on additional risk. These include:
These include:
Diversification
Rebalancing
Small-cap tilt
Equity glide path
Rebalancing
The one I want to focus on today is rebalancing. Investopedia defines rebalancing as "realigning the weightings of a portfolio to its original asset allocation by periodically buying and selling assets." Of the many pieces of financial literature readily available on the internet, that one seems to be the most straightforward and descriptive.
However, that is the definition, and the actual mechanics or practice of rebalancing can be broken down into two separate methods: calendar or threshold.
What’s the Difference?
Calendar rebalancing is the practice of reviewing and returning your portfolio allocation to its target allocation on a fixed schedule via buying and selling.
Example
Every three months, Johnny's financial advisor rebalances his account.
Target Allocation:
Fund A: 25%
Fund B: 25%
Fund C: 25%
Fund D: 25%
Current Allocation:
Fund A: 31%
Fund B: 22%
Fund C: 27%
Fund D: 20%
For various reasons, different funds within your portfolio may outperform the others. That could be due to a shift from tech to value stocks, or international markets are outperforming the U.S. market. Rebalancing is simply buying and selling to bring the current allocation back to the target allocation.
Threshold rebalancing differs in that it is not on a fixed schedule but is based on a fixed bandwidth. For each asset class, a bandwidth of 5% may be set, meaning that at any point the set allocation varies by 5% or more, it triggers an account rebalance. Zooming out on a larger scale, this could look like your 60/40 portfolio (60% equities, 40% bonds) drifting to a 65/35 portfolio due to a strong run in the stock market. This would warrant a rebalance to ensure the investor is maintaining a sufficient allocation to bonds to protect them in the event of a down market. Other benefits include locking in gains and spreading them across other asset classes or market sectors. This essentially creates a buy-low, sell-high effect in your account.
How do either of these benefit my portfolio?
Vanguard conducted a study in 2019 that concluded that the best rebalancing approach is a hybrid of calendar and threshold rebalancing.
The reason is that the two approaches are polar opposites; the hybrid catches what you would miss by going strictly calendar or strictly threshold. The threshold catches extreme drift events between calendar dates. The calendar review catches moderate drift that never quite triggered the threshold but has accumulated quietly over time. Together, they cover each other's blind spots.
It is important to note that in retirement accounts (IRAs, 401(k)s, 403(b)s), you do not realize a gain from the rebalance, since these accounts are tax-deferred. When dealing with taxable brokerage accounts, be aware of potential tax liabilities that can arise from buying and selling, especially if the account’s embedded gains are large.
Our Commitment to You
At Whitaker-Myers Wealth Managers, we place a strong emphasis on capturing every available “free lunch” for our clients to help ensure we are as proactive as possible when planning for retirement and pursuing other financial goals. That is why we have a dedicated portfolio trader, Barbie Cyphers, who oversees all trading-related activities, from portfolio rebalancing to tax-loss harvesting.
Whether you are searching for a new financial advisor or meeting with your current one, it is always worthwhile to ask what strategies and opportunities they are utilizing on your behalf. Taking advantage of these value-added opportunities can play an important role in growing your assets and positioning you for long-term financial success.
