Portfolio rebalancing
A portfolio set to 60% stocks and 40% bonds does not stay there. Rebalancing is the rule for pulling it back, and it is a strategy in its own right.
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Calendar or threshold
- Calendar: rebalance every quarter or year, whatever happened.
- Threshold bands: rebalance only when a weight drifts more than, say, 5 percentage points from target.
Studies by Vanguard found little difference in long-run return between monthly, quarterly and annual schedules; more frequent rebalancing mostly adds costs.
What rebalancing does
It sells what has risen and buys what has fallen, which is a mild form of mean reversion. Its main job is risk control: without it, a 60/40 portfolio after a long bull market can quietly become 80/20.
Costs and taxes
Use new contributions and dividends to buy the underweight asset before selling anything. In taxable accounts, realising gains to rebalance has a real cost.
Practice
Three quick tasks. Pick an answer to check it, or open the answer below each task.
A 60/40 portfolio is now 70/30 after a rally. Rebalancing means...
Show answer
Selling stocks and buying bonds. Trim what grew, add to what lagged.
What is the cheapest way to rebalance?
Show answer
Direct new contributions to the underweight asset. Contributions and dividends rebalance without selling.
With a 5-point threshold band around 60%, when do you act?
Show answer
Above 65% or below 55%. Only when the weight leaves the 55-65% band.
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