Rebalancing Frequency and Safe Withdrawal Rates
Safe-withdrawal rate (SWR) research has traditionally assumed annual portfolio rebalancing, and this is the frequency suggested by many advisors (although some suggest quarterly, monthly, or even daily rebalancing!). But is such frequent fiddling necessary? Rebalancing generates costs in fees and commissions and, depending on the type of account, will trigger tax liabilities.
I used the “Big Picture” client education software to examine the impact of rebalancing frequency on historical SWRs and other retirement outcomes. The results argue against the notion to rebalance often.
The Big Picture software allows advisors to build hypothetical portfolios using up to 11 major asset classes and back-test them over hundreds of rolling historical periods at one-, three-, and five-year rebalancing frequencies.
The Big Picture program uses actual historical performance of indexes and inflation, based on monthly frequency total return data.
To test the effect of different rebalancing frequencies, I started with a “base case” portfolio of 60% large-cap stocks and 40% intermediate-term government bonds. I created three additional portfolios by holding the bond allocation constant while adding other equity classes. Portfolio 1, our 60/40 base case, had one equity class. Portfolio 2 had two equity classes. And so on, up to Portfolio 4.
The following table describes the composition of the test portfolios:
Adding equity classes in a different order would have produced different results. I chose the above order to ensure that all portfolios (except portfolio 1) contained international stocks – a frequently recommended constituent for achieving diversification.