Rebalancing
Rebalancing restores the original allocation by selling what's risen and buying what's fallen. It serves risk control, not higher returns.
Start with seventy percent stocks, and after a few good years you might have eighty-five percent stocks. Without doing anything, your risk has risen considerably.
Rebalancing means going back to seventy. So you sell some of what did well and buy some of what did poorly. That feels wrong, and that's exactly the point.
The purpose is risk control. Rebalancing makes sure your portfolio still carries, ten years later, the risk profile you originally chose.
How often? Once a year is enough, or whenever a position drifts more than roughly five percentage points from its target. More often barely helps and costs fees, and possibly taxes.
Without rebalancing, weighting drifts toward the higher-returning asset, which unintentionally raises portfolio risk. Its primary function is therefore maintaining the chosen risk profile, not improving returns.
An additional return effect can appear with mean-reverting assets, since buying systematically follows relative declines. This effect is empirically small and not present in every period. During sustained trends, rebalancing acts as a drag on returns, since the stronger asset gets continually trimmed.
Two approaches are common in practice: calendar-based at fixed intervals, and threshold-based whenever a deviation band is breached. Studies find small differences between the two, while costs rise noticeably with frequency. During the accumulation phase, rebalancing can be implemented largely for free by directing new contributions preferentially into the underweighted position.
Summary
- Rebalancing keeps your risk constant; it doesn't boost return.
- Once a year, or a five-percentage-point deviation, is enough.
- During accumulation, use new contributions to rebalance and save on costs.
Did you get it?
What happens without rebalancing?
Weighting drifts toward the higher-returning asset, and portfolio risk rises unintentionally.
Does rebalancing always boost returns?
No. During sustained trends it acts as a drag, since the stronger position gets continually trimmed.
How do you implement it cheaply?
By directing new contributions into the underweighted position instead of selling.
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