Rebalancing a Portfolio

Why an investment mix drifts over time as markets move, and how periodically rebalancing keeps risk in line with your plan.

Many investors choose an asset allocation: a planned mix of investments, such as 60 percent shares and 40 percent bonds. Over time, as markets move, this mix changes. Rebalancing means bringing it back to the target.

Why portfolios drift

If shares rise faster than bonds, shares become a larger share of the portfolio. A 60 to 40 mix might become 70 to 30. This means the portfolio is riskier than planned, because shares are more volatile.

If shares fall sharply, the mix might become 50 to 50, less risky than planned but possibly with lower expected returns.

How rebalancing works

To rebalance, an investor sells some of what has grown beyond its target and buys what has fallen below. This can be done by:

Selling and buying existing investments.
Directing new savings to the underweight asset, which avoids selling.

When to rebalance

Common approaches:

Calendar-based: rebalancing at set times, such as once a year.
Threshold-based: rebalancing when an asset moves more than a set amount, such as 5 percentage points, from its target.

Benefits

Risk control: keeps risk in line with the investor’s plan.
Discipline: rebalancing means selling assets after they have risen and buying after they have fallen, the opposite of emotional investing.

After a market boom

An investor starts with 600,000 rupees in equity funds and 400,000 rupees in debt funds. After a strong year for shares, she has 780,000 rupees in equity and 420,000 rupees in debt, about 65 to 35. To return to 60 to 40, she moves 60,000 rupees from equity to debt. If the market later falls, her portfolio is less exposed than it would have been.

Costs to consider

Rebalancing may involve transaction costs and taxes on gains. Using new contributions to rebalance, or rebalancing only when the mix drifts significantly, can reduce these costs.

Thinking rebalancing means selling your winners foolishly

Rebalancing does trim investments that have done well, but its purpose is to keep risk at the level you chose. Letting winners grow unchecked can leave a portfolio much riskier than intended.

Key takeaways

Asset allocation is a planned mix of investments.
Market movements cause the mix to drift, changing risk.
Rebalancing restores the target mix through selling, buying or directing new savings.
It controls risk and enforces discipline, but costs and taxes should be considered.