I used to work with a woman whom I’ll call Kathy. We were both high school English teachers. It wasn’t an easy job, and Kathy often stayed at school until 8pm so she could refine her next day’s lessons. Kathy figured that the harder she worked, the better her students would perform. Unfortunately, as with most good things, there’s often a tipping point. Kathy worked too hard. She was often tired, agitated, and inflexible when her lessons didn’t go according to plan. Ironically, if she had spent less time planning, she might have been a better teacher.

If something is good (like hard work) it doesn’t always mean more of it is better. That applies to investment strategies too.

We know that investors should set a goal allocation and try to maintain it. In other words, they might choose 70 percent stocks and 30 percent bonds. Each of their investments will perform differently. When rebalancing a portfolio, investors skim from the profits of their winners, adding the proceeds to their lower performing asset class. This ensures that the investors maintain something close to their goal allocation.

By doing so, they can reduce their portfolio’s volatility. Sometimes, it can even boost returns. Most experts recommend rebalancing once a year. But if rebalancing were good, would more of it be better? Some people think so. They might rebalance once a quarter. Others rebalance once a month. But does this help, or is it more like flossing your teeth every hour?

We can measure a portfolio’s volatility based on something called, standard deviation. If one portfolio has a higher standard deviation than another, it means it jumps around more. For example, stocks are more volatile than bonds. According to portfoliovisualizer.com, the standard deviation for a portfolio comprising 100 percent U.S. stocks was 15.06 percent from January 1986 to May 31, 2019. In contrast, a portfolio comprising 100 percent in U.S. treasury bonds had a standard deviation of just 4.86 percent. This is a fancy way of saying, stocks are like Mexican jumping beans and bonds are like butter beans.

Here’s how rebalancing reduces volatility. Assume an investor’s portfolio comprised 50 percent U.S. stocks and 50 percent U.S. treasury bonds. If it weren’t rebalanced, it would have recorded a standard deviation of 9.96 percent, from January 1986 to May 31, 2019. If, on the other hand, it were rebalanced once a year, its standard deviation would have dropped to 8.39 percent. In other words, rebalancing once a year would have reduced volatility.

I’ll use a diversified model for another example: 40 percent U.S. stocks, 30 percent international stocks and 30 percent in U.S. bonds. From January 1986 to May 31, 2019, such a portfolio would have averaged a compound annual return of 8.43 percent if it weren’t rebalanced. Its standard deviation would have been 11.54 percent.

By rebalancing once a year, investors would have increased returns and reduced volatility. They would have averaged a compound annual return of 8.57 percent, and their standard deviation would have been 10.35 percent.

But if an investor rebalanced more frequently, they would have been disappointed. By rebalancing quarterly, their compound annual return would have been 8.48 percent and their portfolio’s standard deviation would have been 10.48 percent. In this case, rebalancing more frequently reduced returns and increased volatility.

If an investor rebalanced monthly, their returns would have suffered further. They would have averaged a compound annual return of 8.38 percent, and their portfolio’s standard deviation would have been 10.46 percent. In other words, monthly rebalancing would have reduced returns and increased volatility, compared to rebalancing once a year.

Does More Frequent Rebalancing Boost Returns Or Reduce Volatility?
January 1986-May 31, 2019

Rebalancing Frequency Standard Deviation Compound Annual Average Return
None 11.54 8.43%
Annually 10.35 8.57%
Rebalancing Quarterly 10.48 8.48%
Rebalancing Monthly 10.46 8.38%

This doesn’t mean, however, that annual rebalancing will always juice returns, compared to not rebalancing a portfolio at all. Consider the period from January 2009 to May 31, 2019. U.S. stocks soared and international stocks lagged. During this period, returns would have been better if investors hadn’t rebalanced at all. Not rebalancing would have delivered a compound annual return of 9.24 percent. By rebalancing once a year, investors would have averaged a compound annual return of 8.57 percent.

But this doesn’t mean you shouldn’t rebalance. Sometimes, it boosts returns; sometimes it doesn’t. But it always reduces volatility. Paradoxically, more frequent rebalancing doesn’t improve anything. So do yourself a favor. Rebalance once a year. And remember…we sometimes move backward when we do more work.

Does More Frequent Rebalancing Boost Returns Or Reduce Volatility?
January 2009 -May 31, 2019

Rebalancing Frequency Standard Deviation Compound Annual Average Return
None 11.11 9.24%
Annually 10.08 8.57%
Rebalancing Quarterly 10.12 8.65%
Rebalancing Monthly 10.18 8.56%

Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacherand Millionaire Expat: How To Build Wealth Living Overseas