What Is Rebalancing?
Rebalancing is the process of adjusting your portfolio back to its original target allocation. Over time, some assets grow faster than others and cause the portfolio to drift from its intended risk level. Rebalancing restores the intended mix and helps control risk and discipline.
Why Rebalancing Matters
- Portfolios drift: If stocks outperform bonds, your allocation becomes more aggressive than intended.
- Keeps risk consistent: Your risk tolerance shouldn't change because markets moved.
- Forces buy low, sell high: Rebalancing sells some winners and buys some laggards automatically.
- Prevents emotional investing: Rules reduce guesswork and panic decisions.
- Improves long-term stability: Rebalanced portfolios often show lower volatility and better risk-adjusted returns.
How Rebalancing Works (Simple Explanation)
Example target: 60% stocks / 40% bonds. After a period of growth, stocks rise and the portfolio becomes 70/30 — increasing risk. Rebalancing sells some stocks and buys bonds to return to 60/40, restoring the intended risk profile.
Types of Rebalancing
- Time‑based: Rebalance on a schedule (monthly, quarterly, annually). Simple and predictable.
- Threshold‑based: Rebalance when allocations drift beyond a set threshold (e.g., ±5%). Responsive to market moves.
- Hybrid: Combine schedule and thresholds — rebalance on schedule or earlier if thresholds are breached.
Rebalancing Examples
Example 1 — Simple drift
Target: 50% stocks / 50% bonds → After growth: 65% stocks / 35% bonds → Rebalance: sell stocks, buy
bonds to
restore 50/50.
Example 2 — Crypto drift
Target: 10% crypto → After rally: 25% crypto → Rebalance: reduce crypto to 10% to avoid excessive
volatility.
Example 3 — Defensive drift
Target: 70% stocks → After crash: 55% stocks → Rebalance: buy stocks to return to 70% (emotionally
difficult
but mathematically sound).
How Rebalancing Affects Risk
Without rebalancing, high-growth assets dominate and increase portfolio risk and drawdowns. With rebalancing, risk stays aligned with goals, volatility is controlled, and portfolios remain stable. Rebalancing is risk management, not market timing.
Rebalancing and Taxes
In taxable accounts, selling can trigger capital gains, so investors may rebalance less often or use new contributions and dividends to rebalance. In tax-advantaged accounts (IRAs, 401(k)s), rebalancing has no immediate tax cost and is easier to perform.
How Your Optimizer Uses Rebalancing
- Compares current allocation to optimal weights and identifies drift.
- Highlights concentration risk and suggests trades to restore balance.
- Suggests rebalancing actions considering costs, taxes, and trading limits.
- Incorporates rebalancing into backtests to estimate long-term effects.
How Often Should You Rebalance?
No perfect answer — common guidelines:
- Beginners: Once or twice per year.
- Balanced portfolios: Quarterly or semi‑annually.
- High‑volatility portfolios (crypto, tech): Quarterly or threshold‑based.
- Taxable accounts: Less frequent, or use new contributions for rebalancing.
FAQ
Does rebalancing improve returns?
It typically improves risk‑adjusted returns and reduces drawdowns; raw returns may or may not increase depending on market behavior.
Is rebalancing necessary?
Yes — unless you want your risk level to drift unpredictably. Rebalancing preserves your intended exposure.
Does rebalancing work with crypto?
Yes — it’s especially important for volatile assets. Consider smaller target weights and threshold rules.
Is rebalancing market timing?
No — it’s a rules‑based discipline designed to control risk and enforce long-term strategy.
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