You decided on 70% equities and 30% bonds. Two years later, after a strong equity rally, you are at 82/18. Without doing anything, your portfolio has become far riskier than what you chose. Rebalancing means returning to the target.
Why it is counter-intuitive, and effective
Rebalancing means selling what has risen to buy what has fallen. It offends every instinct we have. Yet it is precisely this mechanism that imposes the discipline of buying low and taking profits, automatically, without having to forecast anything.
Two methods
- By calendar: rebalance on a fixed date (once or twice a year). Simple, disciplined, inexpensive.
- By threshold: rebalance as soon as a class drifts more than X points (say 5) from its target. More responsive, but requires monitoring.
Do not over-rebalance
Every trade costs fees and, outside tax-sheltered wrappers, can trigger tax on capital gains. Rebalancing too often destroys more value than it creates. Once or twice a year is enough in the vast majority of cases.
The frictionless trick
Rebalance first with your contributions: direct new money towards the under-weighted asset class. You bring the allocation back towards its target without selling, and therefore without fees or tax.
In Earnnest
The Allocation tab flags drift: excessive concentration in one stock or sector, redundant correlations. These are factual alerts, not sell orders.
À retenir
- ✓Without rebalancing, your portfolio drifts towards more risk than you chose.
- ✓Rebalancing mechanically forces you to sell high and buy low.
- ✓Once or twice a year is enough; favour contributions to avoid fees and tax.