Imreviewing some of the literature on rebalancing portfolios, for a report due next week. Hopefully things will become clearer as I dig deeper, but for now there are some puzzles:
1. Should assets be rebalanced on a before- or after-tax basis? If someone has $100,000 worth of bonds in an RRSP and $100,000 worth of stocks in a non-registered account, do they have a 50/50allocation when they are in a 40% tax bracket and $40,000 of the RRSP is due to the government? Would the asset allocation instead be $60,000 bonds and $100,000 stocks, for a 37.5/62.5 allocation?
2. Given capital-gain taxes are triggered when stocks are rebalanced in a taxable account, might it be better to keep stocks in a registered account even though investors are often advised that its more tax efficient to hold stocks in non-registered accounts and income assets in registered accounts?
3. Adding dividends, interest and cash injections to the underperforming asset can minimize commissions and capital-gain taxes. But as portfolios get bigger, it may not be possible to rebalance this way. And even if a portfolio is small enough, what if the overweight asset is in a bubble like tech stocks were in 2000 might it be difficult to bring the underweight assets up to target, or even if one could do so, would they be controlling for risk adequately?
4. How should one rebalance a portfolio with foreign diversification and no currency hedging? For example, what if foreign and domestic stocks rise by the same extent but a decline in the foreign currency offsets the gain in the foreign stocks to leave domestic stocks with a relatively greater weight?
5. When retired and drawing down from a portfolio, does it make sense to rebalance? Here is a paper by Spitzer and Singhthat says no. Or, if using withdrawals to rebalance, should they come from the underweight or overweight class?
Well, thats enough with the puzzles for now .