While there are many different strategies for rebalancing a portfolio, the two strategies we will discuss in this section are: periodic-based rebalancing and percent-range rebalancing.

Periodic-based rebalancing:In periodic-based rebalancing (also called calendar-based rebalancing), you must specify how often you will rebalance your portfolio—monthly, quarterly, or annually. After each designated period of time, you will rebalance your portfolio to make it consistent with the target asset-allocation percentages listed in your investment plan. Allowing longer periods of time to pass between each rebalancing entails less transaction costs but more tracking error—the difference between the return you actually receive and the return you would have received if your portfolio had been at its target asset allocations.

The advantage of periodic-based rebalancing is that it is a simple method. The disadvantage of this method is that it does not account for current market performance, which influences overall portfolio performance.

Percent-range rebalancing:In percent-range rebalancing (also called volatility-based rebalancing), you rebalance your portfolio every time the portfolio’s target asset-allocation percentages stray a predetermined percentage (positive or negative) away from your target percentages (e.g., plus or minus 5 percent). A higher percentage will reduce transaction costs but raise the tracking error, while a smaller percentage will reduce tracking error but raise transaction costs.

The advantage of this method is that it is easy to implement because asset performance will indicate when you should rebalance. The disadvantages of this method include that it is difficult to set an ideal range, and assets with higher target percentages and more volatility will have to be rebalanced more often than assets with lower target percentages and less volatility.

New money/donations (NMD) addendum: Regardless of which rebalancing strategy you use, I recommend that you also consider using an NMD addendum. Since most of you pay yourselves monthly, donate to charities on a monthly basis, and use caution in your selection of assets, you are in a position to combine the aforementioned strategies with a new money/donations strategy, or an NMD strategy.

An NMD addendum may be used when the following situation applies: in the process of rebalancing, you may find that you need to sell assets on which you have large capital gains. If this is the case, you may want to use the new money/donation addendum to donate the appreciated asset instead of selling the asset and paying taxes on the capital gains.

You can donate appreciated assets to churches and other qualified charities in the form of tithing, fast offerings, missionary, and almost any other type of donation listed on the LDS Church ward donation slips or other churches donation slips. The “donation-in-kind” of an appreciated asset can take the place of your annual tithing, fast offerings, or other charitable contributions. Then, since you have paid your tithes and offerings through donated securities, you can use the cash that you would have paid for your contributions to buy securities to rebalance your portfolio back to your asset allocation target percentages. (For more information on how to donate appreciated assets to the LDS Church, please see the LDS Church website at lds.org) Within about four weeks of donating an asset to the Church, you will receive a donation-in-kind receipt (see Learning Tool 8: Tithing Share Transfer Example in the Learning Tools section of this website). Keep this receipt as well as a copy of the Wall Street Journal to verify the value of the asset on the day you made your donation. You can then use these two documents to report a charitable donation on your tax return next year.

The key to rebalancing is to minimize market impact, transaction costs, and taxes due. By donating assets “in-kind,” you eliminate capital gains taxes on your donated assets, you minimize transaction costs and market-impact costs, you make a contribution to a reputable charity (the charity must be a 501c3 organization), and you get a tax deduction.

Which rebalancing method is best? For most people, the strategy that is easiest for them will likely be the strategy that is most useful for them. A combination of periodic-based rebalancing and percent-range rebalancing usually works well, especially for smaller portfolios. These strategies can also be combined with the new money/donations addendum. Remember, the goal of rebalancing is to minimize market impact, transaction costs, taxes, and tracking error.