Whether advisors are rebalancing by hand, with spreadsheets or with rebalancing software like Total Rebalance Expert®, they typically rebalance based on tolerance ranges.
A tolerance range sets the high and low bars for particular holdings in clients’ portfolios. How do advisors choose these ranges? They tend to choose the range – commonly plus or minus 20% - to maintain the chosen investment allocation while optimizing the number of transactions. In other words, the range is chosen based on a subjective opinion of what is “too far out” while ensuring that trades are not initiated too often.
This Website Is For Financial Professionals Only
While this strategy has apparently worked for most advisors, it might not be ideal. Because advisors construct models to achieve risk/return efficiency, allowing standardized tolerance ranges might not result in appropriate maintenance of the target risk/return. For example, it is possible that allowing a 20% deviation in a higher risk investment could result in a material impact on the portfolio’s risk/return profile more so than a 20% deviation in a lower risk bond fund.
When proposing rebalancing trades, what if a particular trade produces a large taxable gain? Would the advisor be inclined to not make the trade if the risk/return composition would not be materially impacted?
A tool like MacroRisk Analytics® can provide this type of information. Yet, relying solely on risk analysis software might be cumbersome. Consider a combination of methodologies – rebalancing based on tolerance ranges as targeted or adjusted based on risk analytics. A system combining MacroRisk Analytics and Total Rebalance Expert offers advisors the opportunity to compare a risk measure, the Composite MacroRisk Index (CMRI), for the “before” and “after” portfolio, the “before” portfolio and the “target” portfolio, the “after” portfolio and the “target” portfolio, or a combination of all of the above. Additionally, the CMRI can be used to compare models, alternative funds, etc.