Rebalancing

Rebalancing Your Portfolio: Definition, Strategies, and Examples

Key takeaways
* Rebalancing restores a portfolio’s asset allocation to match an investor’s target mix and risk profile.
* Common strategies include calendar rebalancing, constant-mix (band) rebalancing, constant proportion portfolio insurance (CPPI), and smart beta.
* Regular rebalancing helps control unintended risk drift but can incur transaction costs and may forgo additional gains from top-performing assets.
* Review allocations at least annually or when holdings move beyond preset tolerance bands; follow an investment plan to guide decisions.

What is rebalancing?
Rebalancing means buying and selling assets to return each holding to its target weight in a portfolio. Market movements change asset values over time, so rebalancing keeps the portfolio aligned with an investor’s risk tolerance and goals. It isn’t about forcing a 50/50 split—target allocations can be any mix (for example, 70/30, 40/60, or multi-asset blends) that suit the investor.

Why rebalancing matters
* Maintains intended risk exposure. If equities outperform, they can dominate a portfolio and increase volatility beyond the investor’s comfort zone.
* Enforces discipline. Selling relatively strong performers and adding to underweighted areas helps “sell high, buy low” rather than chasing trends.
* Keeps a portfolio consistent with changing goals. Allocation can be shifted toward more conservative assets as retirement or other objectives approach.

When to rebalance
There’s no single correct schedule. Common approaches:
* Time-based (calendar): review on a fixed schedule—annually, quarterly, or monthly. Annual reviews are common for long-term investors.
* Threshold-based (band): rebalance when an asset class moves outside an allowable tolerance (for example, +/- 5%).
Use an investment plan that defines targets, tolerances, and costs so rebalancing is predictable and consistent.

Rebalancing strategies
Calendar rebalancing
* Adjust holdings at predetermined intervals regardless of market moves.
* Simple and low-maintenance, but may miss large intra-period shifts.

Constant-mix (bands or corridors)
* Each asset class has a target weight and a tolerance band (e.g., 30% ±5%).
* Rebalance only when a class moves outside its band, balancing responsiveness with fewer trades.

Constant Proportion Portfolio Insurance (CPPI)
* Sets a floor value for the portfolio and allocates between a risky asset and a conservative asset based on a “cushion” (portfolio value minus floor) multiplied by a leverage coefficient.
* More active and aggressive; aims to limit downside while participating in upside without using options.

Smart beta rebalancing
* Rules-based rebalancing that weights securities using factors (value, quality, momentum, risk) rather than market capitalization.
* Systematic, reduces emotional decision-making, and periodically trims top performers to reallocate to underweights according to the rules.

Practical examples
Rebalancing retirement accounts
* Younger investors often maintain higher equity allocations for growth, shifting toward bonds and cash as retirement approaches. Regular rebalancing implements that glide path.

Rebalancing for diversification
* If one stock or sector balloons in value, rebalancing reduces concentrated exposure by moving gains into other holdings, helping stabilize long-term returns.

Pros and cons
Pros
* Keeps portfolio aligned with goals and risk tolerance.
* Disciplined approach that mitigates unintended concentration and risk drift.
* Flexible—can be tailored to personal goals, tax situations, and time horizon.

Cons
* Transaction costs and potential tax consequences (capital gains).
* Selling winners can miss further upside.
* Requires a plan and some investment knowledge; excessive rebalancing increases costs.

Common questions
What does rebalancing mean?
It means trading holdings so each asset class returns to its target percentage of the portfolio as set by an investment plan.

Does rebalancing have costs?
Yes—trading fees, bid-ask spreads, and taxes can reduce net returns. There’s also the opportunity cost of selling assets that continue to rise.

How often should I rebalance?
That depends on goals, risk tolerance, and costs. Many investors review allocations annually; others use tolerance bands and rebalance only when allocations stray beyond those limits.

Bottom line
Rebalancing is a core portfolio-management tool that preserves your intended asset mix and risk profile. Choose a clear plan—define targets, tolerances, frequency, and tax-aware execution—and stick to it to manage risk and maintain alignment with your financial objectives.