What is rebalancing — and why do investors do it?
What is rebalancing?
Rebalancing is a core idea in portfolio management. It means bringing your portfolio back to the risk allocation you originally chose after markets have moved.
For example, if you start with:
- 60% stocks
- 40% bonds
…then different returns over time will change the mix. Stocks may end up taking a larger share, and bonds a smaller one — without you making an intentional decision.
Rebalancing means adjusting back to 60/40.
Rebalancing isn’t an attempt to predict the market — it’s risk control.
Why does the portfolio drift on its own?
Markets don’t move evenly. In some periods stocks do much better than bonds; in other periods it’s the opposite.
If you don’t rebalance, the portfolio gradually drifts toward whatever has performed best recently. That usually means:
- risk slowly increases in good times
- losses become larger when the market turns
Often this happens without the investor noticing.
Illustration 1: The portfolio drifts over time
What do you gain by rebalancing?
1. Risk stays (roughly) constant
When you rebalance, you help ensure the portfolio keeps reflecting your risk tolerance — not the market’s mood.
That means:
- less risk of unexpectedly large losses
- a higher chance you’ll stick to the strategy
2. Rebalancing creates discipline
Rebalancing forces you to do something that often feels wrong:
- sell some of what has gone up a lot
- buy some of what has lagged
That’s emotionally difficult, but strategically strong. The process is mechanical and independent of headlines and sentiment.
3. Better risk-adjusted outcomes
Rebalancing isn’t mainly about maximizing returns. It’s about improving the trade-off between return and risk.
Historically, rebalanced portfolios have often:
- had lower volatility
- experienced smaller drawdowns
- produced a more stable long-term journey
Illustration 2: Same outcome — different experience
How often should you rebalance?
There are two classic approaches:
-
Time-based
- e.g., once per year
- simple and predictable
-
Threshold-based
- e.g., if an asset class deviates by more than 5 percentage points
- more precise risk control
Many investors use a combination.
Rebalancing isn’t free
In theory, rebalancing is often assumed to be frictionless. In practice, there may be:
- trading fees
- spreads
- practical constraints
That means the “optimal” rebalancing frequency in real life is often lower than in academic models.
Theory vs reality
Rebalancing is a powerful tool for risk control and discipline. But classic theory often assumes an ideal setup without frictions.
In real life — and especially in some countries — taxes and account rules can make rebalancing more complicated than the theory suggests.
In a future article, we’ll look more closely at why rebalancing isn’t always optimal in Denmark — and how to adapt the strategy in practice.
Short summary
- Rebalancing helps keep risk stable over time
- It prevents the portfolio from drifting in one direction
- It creates discipline and reduces emotion-driven decisions
- It often creates a more stable long-term investing experience
- But theory and practice are not always the same
Rebalancing isn’t a trick. It’s basic portfolio management.