Portfolio Rebalancing: What, When, Why, and How
Optimal rebalancing frequency, threshold strategies, and more
If you have never heard about rebalancing or would like to a get a quick refresher of what it is, then you are at the right place.
Rebalancing is the periodic buying and selling of assets to maintain your target investment allocation percentages.
Let's dive into FIVE essential aspects of portfolio rebalancing that every investor should understand.
1. Why Rebalance?
Rebalancing allows investors to maintain intended risk-return profiles and prevent over concentration into one position. Throughout the year, assets increase or decrease in value and that causes asset percentages to drift from target allocation, increasing portfolio risk. Here is an example of how that happens:
Let’s say the SPY (a fund that tracks the S&P 500) goes up 25% in one year. If an investor has a $100,000 portfolio…
50% is SPY ($50,000)
50% is cash ($50,000)
He wants to maintain that 50/50 ratio.
The portfolio at the end of the year would look as such:
~55% SPY ($62,500)
~45% Cash ($50,000)
At the end of the year, the investor would sell $6,250 of SPY to maintain the 50/50 Ratio. As an extra benefit, this disciplined rebalancing process naturally enforces a "sell high, buy low" approach.
2. What is the Optimal Frequency for Rebalancing?
As much as we can go into the intricacies of rebalancing, the best approach is a hybrid model. This entails a quarterly review of percentages and if an asset class goes 5% beyond its percentage allocation, then the asset in the portfolio will be trimmed. Using the example above is an easy way to see this. The SPY went about 5% over its target allocation, so now it is trimmed back to 50%. Below are a few references of different ways to think about rebalancing if one wishes to do it a different way:
Calendar-based
Monthly: Too frequent, high costs
Quarterly: Standard institutional approach
Annually: Minimum recommendation
Threshold-based
Individual asset class drift: 5% threshold typical
Portfolio risk metric deviation: Track Sharpe/volatility
Hybrid approach (Best approach)
Quarterly review with 5% threshold triggers
Best balance of control and cost
3. Implementation Framework
To implement a structured rebalancing system, set up quarterly calendar reminders for January 1st, April 1st, July 1st, and October 1st. (or any time spaced out 3 months apart)
Block 30 minutes for each review and label it "Portfolio Rebalance Check."
In your calendar event, include a link to your rebalancing spreadsheet (See Our Portfolios - > Portfolio Split Calculator at the bottom) and a simple checklist:
Log into brokerage
Record current allocations
Compare to targets
Check for 5% drift
Document any actions taken.
This creates a systematic approach while requiring minimal time commitment.
4. Common Mistakes
Here are some common mistakes that have essentially been covered by using the hybrid strategy and setting up the implementation framework above. I think it is important to just list it out and allow people to understand the most important parts of rebalancing mistakes:
Emotional override of process
This is combated by setting up the quarterly rebalancing overview.
Ignoring transaction costs
Not something that is typically taken into consideration as most custodians/brokerages (people who hold the money and stocks) rarely charge excessive fees to buy stocks.
Over-frequent rebalancing
This is combated by creating a 5% threshold on a position.
Poor threshold design
Firms that have low or high thresholds can create high frequency of rebalancing or higher risk profiles, respectively.
5. Tax-Efficient Strategies (ADVANCED)
I think going into tax strategies in detail is beyond the scope of this post and will be discussed in its own separate piece. However, here is a list of what portfolio managers think about for tax strategies when rebalancing:
Use new cash flows for rebalancing
Harvest tax losses while rebalancing
Rebalance bewteen tax-advantaged accounts first
Consider tax lots when selling positions
Conclusion:
Portfolios that use the first 4 essential pieces will do well over the long run. If a portfolio is inclined to really maximize the potential, then using these tax strategies can bring some advantages however they are NOT required to do at all.
To sum everything up directly:
Rebalance the portfolio to maintain proper allocation targets
Set up a quarterly review to see if a position goes over 5% and then trim to put it back to its target allocation
That’s it!
