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Explaining portfolio rebalancing to clients

September 20, 2023 Walt Butler By Walt Butler

Portfolio rebalancing is an important aspect of investment management to increase tax efficiency while minimizing risk by maintaining the desired asset allocation in a portfolio. This strategy involves periodically adjusting the weights of different assets within a portfolio to realign them with the target allocation. By doing so, investors can reduce risk, enhance returns, and minimize tax liability over time. LifeYield gives advisors the resources they need to rebalance their client’s portfolios in the most tax-efficient way, helping to maximize after-tax returns across the household portfolio.

The importance of portfolio rebalancing lies in its ability to control risk and tax exposure. As market conditions fluctuate, certain asset classes may outperform or underperform, causing the portfolio’s allocation to deviate from its original target. Rebalancing allows investors to trim positions in overweight assets and increase exposure to underweight ones, thereby maintaining diversification and preventing the concentration of risk. Advisors can use this opportunity to get client’s portfolios back on track from an asset location perspective, as well as from an asset allocation perspective. 

Moreover, portfolio rebalancing serves as a disciplined approach that helps investors stick to their long-term investment objectives. It mitigates emotional decision-making driven by short-term market fluctuations, ensuring that investments remain aligned with individual financial goals. 

Understanding and implementing tax-smart portfolio rebalancing is essential for effective investment management. Rebalancing enables advisors to maintain control over their client’s household portfolios by systematically adjusting the asset allocation and location according to targeted benchmarks, using LifeYield to minimize tax drag and maximize potential returns.

How Often Should We Be Rebalancing Each Client Portfolio

Rebalancing frequency refers to the frequency at which advisors and clients should adjust their portfolios to maintain desired asset allocation.

The first step in determining if a portfolio should be rebalanced is to determine just how far out of alignment the portfolio is with its target allocation. A common way to measure this difference is by using industry-standard measurements such as portfolio drift or portfolio tracking error. 

For example, let’s say we rebalance a portfolio on Jan 1 and make all necessary trades to bring that portfolio into perfect alignment with its target. After execution, the portfolio allocation theoretically has no “drift” relative to its target.

On Jan 2, prices change. This portfolio begins to “drift” from its target. Chances are, the price changes (up or down) are relatively subtle. The client likely isn’t too concerned over the price changes as they pertain to the asset allocation risk.

Let’s say the next time this portfolio is examined is not until September 1. At this point, the price changes in the portfolio holdings over the course of 8 months could change significantly. In doing so, the portfolio’s asset allocation could have also drifted significantly.

Advisors should be educating clients on the concept of allocation drift and establishing an understanding of when that might trigger a discussion involving rebalance activity.  

LifeYield’s approach involves taking asset allocation to the household level and leveraging the tax benefits of each account type. This approach would use one overall household-level asset allocation where each individual account rolls up to the household.

Financial advisors play a crucial role in guiding investors through the process, emphasizing the importance of tax planning and implementing efficient rebalancing strategies at the household level for overall benefits. 

Tax-efficient strategies used during rebalancing

There are a few “tax efficient” elements to consider when performing a rebalance: 

Implementing these strategies can help advisors minimize tax drag on each client’s household portfolio while maintaining the portfolio’s desired asset allocation.LifeYield provides a way for advisors to efficiently balance their clients’ portfolios at a household level while optimizing their returns.

Role of financial advisors

Financial advisors play a pivotal role in educating investors and guiding them through the process of portfolio rebalancing, ensuring that their investments track their targets and align with their long-term financial goals like retirement income generation. 

Additionally, financial advisors execute rebalancing for their clients often, so they need software that can keep their methodology consistent and eliminate the potential for human error. By utilizing the right software, financial advisors empower their clients to maintain an optimal balance within their household portfolios, which means maximizing potential returns while minimizing risk exposure and tax burden.

Benefits of household-level rebalancing

Household-level rebalancing takes the allocation realignment concept further by moving the asset allocation to the household level instead of at the individual account level. Executing this results in each account having a different asset mix that all rolls up to the desired household asset allocation.

By implementing household-level rebalancing, advisors can optimize after-tax returns for clients by strategically locating assets across different accounts during a rebalance. This strategy influences tax planning as it takes into account the various tax implications associated with different types of investments.

Additionally, household-level rebalancing enables individuals to take advantage of any overlapping investments or redundancies within their portfolios. By identifying and eliminating these duplications, individuals can reduce unnecessary risk exposure and enhance overall portfolio performance.

Incorporating household-level, tax-smart rebalancing strategies is crucial for advisors who seek to optimize their clients’ after-tax returns. It provides a controllable lever the advisor can pull to immediately generate tax alpha and help justify their fee, especially during tumultuous market situations.

How LifeYield Helps with Portfolio Rebalancing

LifeYield software has been tested by some of the largest names in the financial industry. These institutions worldwide have benefited from coordinating accounts within a household and offering rebalancing across an entire firm’s book of business.

However, household-level rebalancing is only one piece of the retirement income optimization pie. In addition to Multi-Account Rebalancing, LifeYield has APIs that execute:

Major financial services firms like Morgan Stanley, Franklin Templeton, and SEI integrate LifeYield APIs with their proprietary advisor technology platforms. Those firms have increased advisor productivity and improved financial results for investors, advisors, and firms as a result of their focus on technology.

Frequently Asked Questions

How often should I rebalance my portfolio?

Portfolio rebalancing should be done regularly to maintain the desired asset allocation. The frequency of rebalancing depends on various factors, such as investment goals, risk tolerance, and market conditions.

For long-term investors who prefer a hands-off approach, rebalancing annually or semi-annually may be sufficient. However, more active traders may choose to rebalance quarterly or even monthly to take advantage of short-term market fluctuations.

No matter the frequency, rebalancing a portfolio at the household level has the greatest impact on future after-tax returns.

What are the potential risks of not rebalancing my portfolio?

The potential risks of not rebalancing a portfolio include increased exposure to market fluctuations, deviation from the desired asset allocation, and loss of diversification.

By failing to adjust the portfolio’s composition, investors may become overexposed to certain sectors or asset classes that perform poorly. This can lead to significant losses during market downturns.

Additionally, neglecting to rebalance may result in a departure from the original investment strategy and long-term goals. The longer a portfolio goes without rebalancing, the risk of becoming tax-inefficient increases significantly.

How can I determine the optimal allocation for my portfolio before rebalancing?

To determine the optimal allocation for a portfolio before rebalancing, advisors should work with each client to understand their goals.

First, assess the client’s desired risk level by considering factors such as investment goals and time horizon.

Then, once you determine the optimal asset allocation, explain the importance of taking a household-level approach. This means the client’s Roth IRA looks different from their brokerage account, but the overall tax efficiency of the portfolio is greater.

Finally, periodically review and adjust the allocation through a tax lens as market conditions change.

Are there any tax implications associated with portfolio rebalancing?

Portfolio rebalancing can have tax implications for investors. When selling securities to rebalance a portfolio, capital gains or losses may be triggered, which can result in tax liabilities. The tax treatment of these gains or losses depends on the holding period and the investor’s tax bracket. It’s important to use technology to ensure accuracy and avoid potential wash sales.

Investors should consider these potential tax consequences when deciding to rebalance their portfolios and consult with a tax professional to ensure compliance with applicable tax laws and optimize their after-tax returns.


Portfolio rebalancing is a crucial strategy in investment management that involves periodically readjusting the composition of a portfolio to maintain its desired asset allocation. It is crucial to regularly monitor and rebalance portfolios as market conditions change to maintain an optimal balance between risk and return. This process aims to control risk and optimize returns by selling overperforming assets and buying underperforming ones.

Walt is the VP of Product Development at LifeYield.