Key takeaways
- Vanguard's 92-year test found a 60/40 rebalanced annually returned 8.19% a year after tax, against 8.74% for never rebalancing.
- The same rebalanced portfolio ran at 11.4% volatility against 14.0%, lifting the Sharpe ratio from 0.46 to 0.51. The benefit was risk.
- Bernstein's original 1996 rebalancing bonus was 0.49% a year, and the next issue called it illusory: buy-and-hold returned 9.17% versus 8.34%.
- Willenbrock's 50/50 stock and long Treasury example earned a 1.12% diversification return over 2000 to 2009, against a synthetic 3.32% benchmark.
- A German study of 15 DAX stocks from 2006 to 2015 found rebalancing returns negative at every frequency, roughly 1.8 points a year behind buy-and-hold.
Two people open identical accounts on the same day and put the same money into the same 60/40 split. One of them rebalances every year without fail — sells whatever ran, buys whatever lagged, for the rest of their life. The other never touches it again.
Ninety-two years later, who has more?
You'd expect the diligent one, and that's the whole promise of the rebalancing bonus. Selling what has risen and buying what has fallen is supposed to be a small, free source of return, paid to you for being disciplined.
Vanguard ran exactly that test, from January 1926 to December 2018. The annually rebalanced 60/40 with a 5% band returned 8.19% a year after tax. The one left completely alone returned 8.74%.
The lazy one won. Not by much — roughly half a percentage point a year — but the direction is the wrong way round, and it stays the wrong way round for the entire 92 years.
So what was the disciplined investor actually buying?
Risk control, and quite a lot of it. Annualised volatility fell from 14.0% to 11.4%, and the Sharpe ratio rose from 0.46 to 0.51. There's also a detail that reframes the comparison completely: the never-rebalanced portfolio finished with an average equity weight of 85%, not 60%. It wasn't a better 60/40. It was a different, riskier portfolio still wearing the 60/40 label.
That distinction is where most of the confusion about the rebalancing bonus lives, and it's worth pulling the two effects apart properly.
What the rebalancing bonus is supposed to be
The term "diversification return" comes from Booth and Fama in 1992. The idea is simple enough. A portfolio held at constant weights compounds faster than the weighted average of its assets' own compound returns. That gap is the diversification return.
Scott Willenbrock, writing in the Financial Analysts Journal in 2011, gives a clean worked example. Imagine you split your money 50/50 between the S&P 500 and Barclays US Long Treasury on 1 January 2000, and rebalance back to even every year end. Over the decade to 2009 the equity leg compounded at minus 0.95% and the Treasury leg at 7.59%. Your blended portfolio compounded at 4.44%, against a weighted average of the two legs of 3.32%. The 1.12% difference is the diversification return.
That's a real gap, and it isn't a rounding error. But look hard at what it's measured against. The benchmark isn't the same portfolio left alone. It's a synthetic blend of compound returns that nobody actually holds — including you.
The original bonus was 0.49%, and its author retracted it
William Bernstein coined the phrase "rebalancing bonus" in a 1996 piece on Efficient Frontier. He used US common stock and long-term corporate bonds over 1926 to 1994, which returned 10.19% and 5.51% a year. The arithmetic blend of the two, which he calls the Markowitz return, is 7.85%. A 50/50 portfolio rebalanced annually returned 8.34%. The bonus: 0.49%.
Half a percentage point. That's the headline figure from the paper that named the effect, and it's already modest. The follow-up is the part almost nobody quotes.
In the next issue, under the title "When Doesn't It Pay to Rebalance?", Bernstein was blunt about his own number. He wrote that the excess return was illusory. Equal amounts in stocks and bonds on 1 January 1926, left alone and untaxed, returned 9.17% a year. That beats the 8.34% from rebalancing. The unrebalanced portfolio simply drifted into being mostly equities, and for the last 40 years of the period it was more than 90% stock.
So the bonus was measured against a benchmark that flattered it, and it vanished against the benchmark you'd otherwise be holding. The same drift mechanism runs on much shorter timescales too, as our look at how far a 60/40 portfolio wanders in a single year shows.
A pound, two rules, 92 years
Say you'd put a single pound into that Vanguard 60/40 in January 1926. It's an illustration — scale it to whatever you'd really have invested, and the shape doesn't change.
Under the first rule you rebalance every year with a 5% band, and your pound compounds at 8.19% a year for 92 years. Under the second you never touch it, and your pound compounds at 8.74%. Over that long a run, half a point a year is not a small difference at the end. Compounding sees to that. The disciplined pound finishes behind, and it finishes a long way behind.
Now look at what each pound had to survive on the way. The rebalanced one rode at 11.4% volatility in a portfolio that stayed close to 60/40. The untouched one drifted to an average 85% equities and rode at 14.0%, which means it fell harder in every bad stretch along the way — and there were plenty. Would you have held the second pound through every crash between then and now without flinching?
That's the actual trade. You paid roughly half a point a year, and what you bought was a portfolio you were more likely to still be holding at the end of it.
Where the diversification return actually comes from
Willenbrock's main contribution is to kill a popular explanation. The diversification return is usually attributed to variance reduction, because the approximation g ≈ r − σ²/2 makes lower variance look like higher compound growth. He argues the mathematics is being read backwards.
The real source is the trading. Rebalancing forces you to sell whatever has risen in relative weight and buy whatever has fallen. That's a contrarian rule, and the rule is what produces the return. Lower variance is necessary but not sufficient.
His test case makes the point sharply. A buy-and-hold portfolio also has lower variance than the weighted average of its holdings. It earns no diversification return at all. Only a rebalanced portfolio does, because only a rebalanced portfolio trades. Willenbrock calls diversification the free lunch of finance and the diversification return the "free dessert", earned while holding the risk profile constant.
So is the dessert worth ordering? It depends entirely on what you're rebalancing. Think of an equally weighted commodity futures index, where the average constituent has a standard deviation near 30%. Willenbrock argues that most of the 4.52% excess return Gorton and Rouwenhorst measured there is diversification return. Volatile assets, similar expected returns, low correlation: that's the recipe. A 60/40 of global equities and hedged bonds is nothing like it. Commodities are the classic case, and commodity index returns show how little of the result is the spot price.
The case against calling it a bonus at all
The sharpest critique comes from Donald Chambers and John Zdanowicz in 2014. They argue that the whole concept rests on a badly chosen benchmark and a confusion between rates and money.
Their reasoning runs like this. Expected portfolio value is governed by arithmetic mean returns, not geometric ones. Volatility drags down the compound rate without reducing expected wealth. A lower-volatility portfolio will therefore show a higher geometric mean than a higher-volatility one with the same arithmetic mean. That looks like added return when nothing has been added.
They state three conclusions. Rebalancing does tend to raise geometric mean returns even when returns are serially uncorrelated, but those higher geometric means don't cause higher expected portfolio values. Rebalancing raises expected value when asset prices are mean-reverting, and the gain comes from the mean reversion rather than from diversification or variance reduction. And the higher geometric mean of a low-volatility portfolio can't be arbitraged against a high-volatility one when both share the same arithmetic mean.
Their reframing is useful even if the full argument doesn't convince you. Call it rebalancing return rather than diversification return, they suggest, and note that it turns positive when prices mean-revert and negative when they trend. That makes it a bet on a return pattern, not a free dessert. It's the same reason volatility and drawdown answer different questions about risk: the measure you pick decides what looks like a gain.
When the bet loses
Bernstein's own formula makes the conditions explicit. For two assets the bonus equals X₁X₂(Var₁/2 + Var₂/2 − Cov₁,₂), which is the difference between the pair's mean variance and their covariance. Higher volatility raises it. Lower correlation raises it. A large gap in long-run returns destroys it, and destroys it further the longer the gap persists.
He put a rough threshold on that last condition. Over 1970 to 1994, rebalancing pairs of national equity markets almost always beat leaving them alone. Only when long-run return differences exceeded about 5 percentage points did the unrebalanced pair win, and then only by carrying more risk. Rebalancing between industry groups has a much worse record, he noted, because whole industries shrink permanently while others grow.
A German study puts numbers on the losing case. Frieder Meyer-Bullerdiek tested an equally weighted portfolio of 15 stocks that had been in the DAX since 1988, using weekly data from January 2006 to December 2015. Over the full ten years, rebalancing produced negative rebalancing returns at every frequency tested. Weekly rebalancing compounded at 0.1167% a week against 0.1485% for buy-and-hold — a shortfall of about 0.032% a week, or roughly 1.8 percentage points a year.
Picture what holding that felt like. Every week you sold a slice of whatever was working and bought more of whatever wasn't, and every week that was the wrong trade.
The decomposition explains it. The volatility return was positive, at 0.0546% a week. It was swamped by a dispersion discount of 0.0864%, because a few stocks trended hard and rebalancing kept selling them. Strip out the five stocks with the most extreme end weights and the rebalancing returns turn positive. That isn't a strategy. That's hindsight.
What happens when you test it properly
Hubert Dichtl, Wolfgang Drobetz and Martin Wambach ran the most careful statistical test in this literature. They applied a double block bootstrap to monthly stock and government bond data for the US, the UK and Germany, from January 1982 to December 2011. Three families of rebalancing were tested: periodic, threshold and range.
Their finding on returns is the one that matters to you. The simulations gave only weak evidence that buy-and-hold returned more than rebalancing, and no significant economic difference in net asset values either. Neither mean reversion nor momentum in the data was strong enough to produce superior returns for either strategy. In the US, the confidence interval around the return difference included zero.
On risk the result is emphatic. Rebalancing at every frequency showed significantly lower volatility than buy-and-hold, and significantly higher Sharpe ratios. Monthly rebalancing produced significantly lower Sharpe ratios than quarterly, in all three countries and at every horizon. That's evidence that trading too often costs you something even before commissions and tax. Their conclusion is that risk reduction explains why rebalancing is so widely used.
Vanguard's table says the same thing from another angle. Thirteen different rebalancing rules produced annualised returns between 8.19% and 8.39%, with volatility between 11.4% and 11.8%. The rule you pick barely mattered. Having one did. Our comparison of annual rebalancing against 5% threshold bands works through those rules in detail.
Bernstein reached the same place in 2000 with a different dataset. Across 24 overlapping 28-year periods starting in 1969, a 40/15/15/30 portfolio returned 12.030% a year rebalanced monthly and 12.267% rebalanced every four years. The average difference between quarterly and four-yearly rebalancing was 18 basis points.
So how big is the rebalancing bonus, really?
Pull the published figures together and a range emerges.
- Bernstein's 1926 to 1994 stock and bond pair: plus 0.49% against the arithmetic blend, negative against buy-and-hold.
- Willenbrock's 2000 to 2009 stock and Treasury pair: plus 1.12% against the strategic return, in a decade when equities went nowhere.
- Vanguard's 92 years: minus 0.55% against buy-and-hold.
- Meyer-Bullerdiek's German equities: minus 1.8% a year.
Every positive figure there is measured against a synthetic benchmark. Every figure measured against the portfolio you'd otherwise be holding is small or negative. The honest summary is that the return effect is close to a coin flip. Its sign depends on whether your assets mean-revert over your holding period, and its size is usually well under a percentage point either way. Costs and tax then eat into whatever is left.
None of that touches the risk case, which is much stronger and much less disputed. Rebalanced portfolios held their target risk; unrebalanced ones drifted upward in equity weight and got hit harder in drawdowns. That effect shows up clearly in what rebalancing did through the 2008 and 2020 crashes, and it's the reason the practice survives despite a return story this thin.
What would change the conclusion
Three findings would move this materially.
First, evidence of reliable mean reversion at the asset-class level. Both Chambers and Zdanowicz and Meyer-Bullerdiek make the bonus conditional on it. Dichtl and co-authors found it too weak to matter across 30 years and three countries. A dataset showing persistent negative autocorrelation at typical rebalancing horizons would turn the bet into an edge.
Second, a different asset mix. The stock-bond evidence is dominated by a 90-year equity risk premium, which is exactly the return gap that kills the bonus. Rebalancing between assets with genuinely similar long-run returns and 30% volatility is where the arithmetic favours it, and where Willenbrock's estimate runs to several percentage points.
Third, a proper cost accounting. Vanguard's figures are tax-adjusted, but the German study ignores transaction costs entirely and says so. Realistic costs would push the return effect further negative while leaving the risk benefit untouched.
The one thing that wouldn't change the conclusion is another backtest showing a rebalanced portfolio with a higher Sharpe ratio. Critics and advocates already agree on that. It's a statement about risk, and it says nothing about a bonus.