Outline common rebalancing strategies and their trade-offs.

• A. Calendar-based rebalancing is predictable and simple; threshold-based rebalancing saves costs but is more complex; tax considerations and transaction costs matter.
• B. Threshold-based rebalancing is always cheaper than calendar-based.
• C. Rebalancing has no tax implications.
• D. Rebalancing is only needed when new money is invested.

Answer: (A)

Rebalancing strategies center on when to trade to restore a portfolio’s target mix, and what costs or risks come with each approach. Calendar-based rebalancing schedules trades at fixed intervals (for example, quarterly or annually). It’s predictable and easy to automate, which helps with discipline and cash-flow planning. But it can cause unnecessary trades if markets move but the allocations stay within tolerance, leading to transaction costs and potential tax consequences, especially in taxable accounts. It can also be suboptimal if market moves create larger drift between cadence dates and you miss timely adjustments.

Threshold-based rebalancing trades only when the portfolio’s actual allocations drift beyond predefined limits. This can dramatically reduce trading and taxes by addressing only meaningful imbalances, and it adapts to market conditions. The trade-off is greater complexity and ongoing monitoring, plus the risk that drift could become sizable before a rebalance occurs, potentially increasing risk or causing a large, concentrated trade that has tax implications in taxable accounts.

Tax considerations and transaction costs matter in both approaches, since realized gains and trading fees shape after-tax returns. In tax-advantaged accounts, tax effects are less critical, but still a factor if funds move in and out. Some investors blend the two approaches to balance predictability with efficiency.