Rebalancing: The Boring Habit That Controls Your Risk

Suppose you chose a split of seventy per cent shares and thirty per cent bonds because it matched how much loss you could tolerate. Three strong years for shares later, you are holding something closer to eighty-five fifteen. Nobody decided that. It happened.

What drift does

The assets that grow fastest become the largest share of the portfolio, so a portfolio left alone always ends up concentrated in whatever has recently performed best. That is precisely backwards: your exposure to an asset rises after it has become more expensive, and it peaks just before the periods that hurt most.

The practical effect is that the loss you experience in the next downturn is larger than the one you signed up for. Investors then discover their real risk tolerance at the worst possible moment and sell.

How to do it

1. Write down the target split and the reason for it. Without a written target there is nothing to rebalance towards, and the temptation is to redefine the target to match whatever you already hold.
2. Choose a trigger. Either a date, once a year is plenty, or a threshold, such as any holding drifting more than five percentage points from target. Both work; using both at once mostly generates extra trades.
3. Rebalance with new money first. Direct contributions to whatever is below target. This corrects the drift without selling anything and avoids the costs and tax that selling can create.
4. Sell only if new money is not enough. Usually true for larger portfolios, where contributions are small relative to the balance.

The part that feels wrong

Rebalancing means selling some of what has done well and buying more of what has done badly. It feels like a mistake every single time, and that feeling is the reason most people skip it.

The discipline is worth naming honestly: you are not predicting that the laggard will recover. You are declining to let a run of performance quietly rewrite the risk level you chose while you were not looking.

When not to bother

• Small portfolios in the early years. Contributions dominate, and directing them sensibly is all the rebalancing you need.
• Single multi-asset funds. A target-date or balanced fund rebalances internally; doing it yourself on top achieves nothing.
• Where costs would exceed the benefit. Frequent rebalancing on a small balance with per-trade charges is a way to pay fees for tidiness.

Otherwise, once a year, on a date you have already chosen, spend twenty minutes bringing the portfolio back to the split you decided on when you were calm. It is the least interesting thing in this section of the site and one of the few that reliably works.