By Tim Courtney, Chief Investment Officer

Maintaining a balance in life is typically considered a healthy goal. It is considered a healthy goal in investment portfolios too. Maintaining balance in life and investing is not easy and requires us to be disciplined. For investing, to keep that balance and avoid drifting off course, we need to rebalance assets every now and then.

The concept of portfolio rebalancing often goes against our instincts. It requires us to pare outperforming assets and to buy underperforming assets. Why would I do that—shouldn’t I have more of a good thing? However, history shows that disciplined investors who pare outperformers and buy underperformers have often been rewarded.

Let’s consider a hypothetical example using a portfolio made up of four equal assets—U.S. Large Growth stocks, U.S. Large Value stocks, U.S. Small Cap stocks and International Value stocks. Using indexes to represent these assets, from 1977 through the end of 2024, each performed nearly identically—12.3% to 12.4% annually. ¹ Buying and holding these would have resulted in a hypothetical average return of 12.37%.¹ However, simply rebalancing the portfolio once a year would have produced a hypothetical average return of 12.87%—a 0.50% higher return annually over 37 years. ¹

Over time, this reward comes from an investor providing the market with what it wants—taking shares of underperformers off its hands and providing it with shares of outperformers. It is what we call being an accommodating investor.

To be fair, it has been difficult to be an accommodating investor over the last decade—a time in which one asset (U.S. Large Growth stocks) far outperformed all other stocks. ² But rebalancing has worked because assets do not outperform forever. Extreme recent performance is often followed by performance that moves overall returns closer to their long-term average. ³

We think there are two primary forces that ultimately drive market behavior. One is momentum, a shorter-term force that pushes over or under-performers to continue moving in the same direction for a while. But assets are eventually affected by a longer-term force we’ll call mean reversion. This is why assets like stocks tend to go through periods of out and under-performance.

The “letting the winners run” strategy can work in the short run by capitalizing on momentum and may even do well over longer periods of time. But it usually leads to a very concentrated portfolio and a reliance on a handful of stocks. ⁴ Will a handful of stocks that have done well in the past continue to outperform? History shows the odds are against it.

The odds can be better when we acknowledge both momentum and mean reversion—the two forces that make a rebalancing benefit possible. There are other reasons to rebalance as well such as managing the overall risk of a portfolio. Think of your portfolio like a rose bush—you’re pruning it to preserve its shape and set it up for future growth. If you have questions about portfolio rebalancing, please contact your advisor.

Sources

1. Exencial Wealth Advisors (3/21/25) – Rebalancing Frequency Study
2. The Motley Fool (2/24/25) – The Magnificent Seven’s Market Cap Vs. The S&P 500
3. American Economic Association (June 1990) – Mean Reversion in Equilibrium Asset Prices
4. State Street Global Advisors (July 26, 2024) – Diversification is Greater Than Concentration

This article contains an example of portfolio allocation which is entirely hypothetical and is being provided for illustrative purposes only. Nothing within is, or is intended to constitute, investment, tax or legal advice or a recommendation to buy or sell any types of securities or investments. Because the example is hypothetical, no individual client or investor received the exact returns illustrated within. Portfolio returns are not guaranteed, and investing in securities comes with varying degrees of risk, including total loss of principal, which an investor will need to be prepared to bear. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of the information provided.

PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971.

Mean reversion is a theory suggesting relevant factors such as, asset prices and volatility of returns, will return to their overall long-term average levels.