Systematic Target-Date Rebalancing: Taking Emotion out of the Equation

The turmoil in the first quarter of 2020 reinforced the importance of rebalancing in target-date design. As we see it, a finely tuned, systematic approach can help keep emotions in check and risk under control—benefits that translate to many types of multi-asset solutions.

So far, 2020 has seemed like the definition of market volatility. The S&P 500 Index swung by more than 2.5% in 18 of March’s 22 trading days. The VIX (or CBOE Volatility Index), a gauge of expected volatility that’s based on S&P 500 option pricing, soared. The so-called “fear index,” which had been in the teens for some time, peaked above 80 in mid-March.

When markets are struggling to find solid footing, portfolio allocations can swing wildly, too, and asset allocations left unattended can drift far out of balance. Portfolios that rebalance based only on the calendar can be left behind in fast-changing markets, and not every rebalancing approach gets the formula right.

For plan sponsors, the first-quarter dislocations were a reminder that rebalancing can be a make-or-break element in target-date design. A long bull market may have masked rebalancing shortcomings, so we think this is a good time to take a fresh look at how target-date funds keep their allocations in line.

Reinforcing Timeless Investing Principles

Rebalancing is an emotional challenge. Humans are hardwired to put more money into investments that are doing well and take money from those that aren’t. It can be hard to make—and justify—reallocation decisions that run counter to emotional current when considering the right time to rebalance.

Systematic rebalancing can change the narrative—a strong framework using trigger points to signal the need to realign exposures. When an outperforming asset’s exposure reaches an upper trigger point, it drives a sell decision. When an underperforming asset’s exposure reaches a lower trigger point, it drives a buy decision (Display). In this way, systematic rebalancing enforces the timeless principle of buying low and selling high.