To compare firms on how they rebalance their clients' portfolios, one needs a standard for what methods are best. A comprehensive study of various methods, published on the Investing section of this site's menu, concluded that over the long term, the best results rest on:
- Rebalancing toward one's target percentages for stocks and bonds when they drift a fixed percentage from their target, rather than doing so by the calendar. In particular, a criterion of 3% or 4% drift has worked better, historically, than rebalancing monthly, quarterly, or yearly. In short, use a percentage trigger, not a calendar date, to decide when to rebalance.
- Limiting the frequency of rebalancing by directing dividends, interest, withdrawals, and new deposits selectively toward target percentages, rather than reinvesting dividends and interest or making deposits and withdrawals in proportion to current or fixed allocations. For example, if stocks were currently 2% below your target, not yet at the 3% to 4% threshold for rebalancing, you would direct interest, dividends, and deposits toward your stock funds, and withdrawals toward your bond funds. This is income placement.
- Relying not on human intervention but instead on an automated process to execute the rebalancing strategy. Doing it yourself, or relying on an adviser to do it for you, is prone to the lapses of attention and fallibility of judgment to which all of us are vulnerable. A decent computer algorithm can do it more systematically and more reliably.
- Keeping the costs low. Rebalancing is never free; you pay with your own time or you pay fees to your investment firm. The fees may not be obvious, but they are there. Fees of 0.50% are too high, particularly for portfolios with 40% or less invested in stocks. Historical analysis of various portfolios and rebalancing methods implies that the biggest benefits of rebalancing are 1% or more, over the very long run, using the very best methods, for portfolios with 60% or more in stocks. On the other hand, weaker methods, such as quarterly rebalancing, have tended to return less than 0.50% in the long run, particularly when 40% or less is invested in stocks.
I used these four standards to evaluate the methods of rebalancing offered by the four firms in this year's analysis. In rank order, best first, here is how I rate them:
- Betterment uses a fully automated process that does income placement and that rebalances with 3% drift as its trigger. The fee is 0.25% of your portfolio's value, deducted quarterly. For accounts over $100,000, this charge is higher than last year's 0.15%; for small, starter accounts, the current charge is lower than last year; and for very large accounts, the 0.25% charge is limited to the first $2,000,000. To be fair, Betterment would assert that the 0.25% fee covers more than rebalancing. For example, it supports online access to tools for setting financial goals, and it enables Betterment to find the best funds for a portfolio that fits your goals and time-horizon. Other firms would make similar argument for their fees. Still, Betterment's 0.25% is not the lowest available charge for rebalancing (that prize goes to one of Vanguard's methods).
- Wealthfront also uses a fully automated process that does income placement and rebalances when drift exceeds a trigger, at a fee of 0.25%. It's a close call, but I rate them slightly below Betterment for one reason: transparency. They don't disclose the threshold for their trigger. If it were too small (below 2%) or too high (above 5%) then the benefit of rebalancing would be greatly diminished, according to the historical data.
- Vanguard offers rebalancing in two ways. One option is to use their all-in-one funds, such as their target-date or LifeStrategy funds. These charge about 0.05%, a pittance, over the already low cost of the underlying index funds. However, the all-in-one funds essentially use continuous or monthly rebalancing, which has historically generated much weaker benefits than a 3% or 4% trigger. In a word, it's both the least expensive method and the least effective. A second option from Vanguard is to pay one of their advisers a fee of 0.30% to rebalance your funds manually, probably every quarter. Perhaps you could get them to do so with a percent-trigger, rather than quarterly; even then their costs would be higher and their methods less automated than Betterment and Wealthfront. The bottom line is that Vanguard's methods are better than do-it-yourself, but not the best available.
- FutureAdvisor is part of Blackrock Solutions, whose parent company also owns the iShares family of ETFs. Although FutureAdvisor has products and attributes that make them attractive for some investors, rebalancing is not a strong point. They use a percentage trigger, which is good, but (like Wealthfront) they don't disclose their threshold. Worse yet, they charge 0.50%. If rebalancing were your only concern, any of the other firms reviewed here would be a better choice than FutureAdvisor.