Rebalancing

Over time, different investments grow at different rates, so a portfolio drifts away from its intended mix. Rebalancing restores the original balance of risk.

Suppose you start with 100,000 split 60% shares and 40% bonds. After a strong year for shares, your shares are worth 72,000 and your bonds 40,000, a total of 112,000. Shares now make up about 64% of the portfolio. To return to 60%, you would sell about 4,800 of shares and buy bonds with the proceeds.

Rebalancing has a useful side effect: it naturally sells assets that have risen and buys those that have fallen, which is the opposite of what emotions often push investors to do.

There are two common approaches. Calendar rebalancing happens at fixed intervals, such as once a year. Threshold rebalancing happens whenever an asset moves more than a set amount, such as five percentage points, away from its target. Transaction costs and taxes should be considered, which is why many investors rebalance only occasionally or use new contributions to restore balance.