REBALANCING EXPLAINED: WHEN AND HOW INVESTORS DO IT

What is Portfolio Rebalancing?

Portfolio rebalancing is a fundamental investment strategy used to realign the weightings of assets within a portfolio to maintain a desired level of asset allocation—commonly between equities, fixed-income securities, and alternative investments. Over time, due to market movements, these weightings can shift away from an investor’s target allocation. Rebalancing is the process of realigning these proportions back to intended levels.

For example, an investor might begin with a portfolio that’s 60% equities and 40% bonds. Over a year, strong performance by the equity markets might shift that allocation to 70% equities and 30% bonds. While this change may initially seem positive due to increased equity value, it simultaneously exposes the investor to higher levels of risk. Rebalancing would involve selling a portion of equities and buying bonds to return to the original asset mix.

By doing so, investors systematically follow a disciplined approach, often forcing themselves to 'sell high and buy low'—selling outperforming assets and buying underperforming ones. This approach can be particularly valuable for maintaining risk levels associated with a personal risk tolerance or long-term financial goals.

There are several motivations behind rebalancing, including:

• Risk Management: An unbalanced portfolio can expose an investor to unwanted levels of volatility.
• Goal Alignment: A portfolio should match the investor’s financial objectives, which may change over time.
• Stability: Regular rebalancing helps keep a consistent investment strategy and avoids emotional decision-making.
• Maximising Tax Advantage: Rebalancing can facilitate tax-loss harvesting when conducted strategically.

However, rebalancing is not without its challenges. Potential downsides include transaction costs, tax implications when selling investments in taxable accounts, and the difficulty of timing rebalances optimally. Nonetheless, for long-term investors, periodic rebalancing remains an essential tool in wealth management.

Ultimately, rebalancing brings an investor’s portfolio back within a structured framework. Rather than letting emotions drive investment decisions—especially in turbulent markets—it introduces a systematic discipline designed to meet one's risk tolerance and return objectives.

How Often Should You Rebalance?

Deciding how frequently to rebalance a portfolio is a critical component of investment strategy. There is no one-size-fits-all frequency, and different investors may adopt different schedules depending on their financial goals, market outlook, transaction costs, and portfolio composition. Common rebalancing frequencies include quarterly, semi-annually, and annually, although some investors choose to rebalance according to market movements or asset drift thresholds.

Time-Based Rebalancing: Perhaps the most common method, this involves rebalancing on a set schedule—such as every six months or once per year. This approach is straightforward, predictable, and removes emotional bias. Investors simply review their portfolio at specific intervals and adjust allocations back to target levels.

Threshold-Based Rebalancing: This strategy triggers a rebalance whenever an asset class deviates from its target allocation by a predetermined percentage, such as 5% or 10%. For instance, if equities rise from 60% to 66% in a portfolio with a 60/40 target, it would trip the 5% threshold and warrant a rebalance.

Threshold-based rebalancing introduces responsiveness to market changes and can help investors handle volatility better. However, it also requires more frequent portfolio monitoring and potentially higher transaction and tax costs.

Hybrid Approach: Some investors combine time- and threshold-based strategies. For example, they might regularly review their portfolio quarterly but only rebalance if asset class deviations exceed a certain threshold. This approach provides both structure and flexibility.

Rebalancing in Tax-Advantaged vs. Taxable Accounts: Frequency may also depend on account type. Rebalancing in tax-advantaged accounts—like pensions or ISAs—is typically tax-neutral, meaning investors can rebalance more frequently without tax implications. In taxable accounts, however, frequent rebalancing can generate capital gains taxes, particularly if profitable assets are sold. This makes strategies like tax-loss harvesting and careful sequencing of asset sales critical.

Market Volatility Considerations: During periods of significant market swings, more frequent rebalancing may help reduce risk more effectively. Conversely, in stable markets, less frequent rebalancing may suffice.

Ultimately, choosing how often to rebalance comes down to an investor’s goals, risk appetite, portfolio complexity, and sensitivity to costs. Financial advisers often recommend reviewing allocations at least annually, while high-net-worth individuals or institutional investors might opt for more dynamic approaches using automated tools or managed portfolio services.

Regardless of the frequency, consistency is key. Sticking to a chosen plan—rather than reacting to every market move—can significantly improve long-term investment outcomes.

Rebalancing Strategies and Tools

A variety of strategies and tools can help investors rebalance efficiently, depending on the size of the portfolio, its complexity, and the investor’s level of engagement. From manual rebalancing to automated robo-advisors, the methods vary widely in sophistication and cost.

Manual Rebalancing: Ideal for hands-on investors with relatively simple portfolios, this method involves regularly reviewing allocations and executing buy or sell orders to return to target levels. Manual rebalancing gives complete control but requires discipline, time, and attention to detail—especially with taxable events and transaction fees.

Robo-Advisors: Many automated investment services such as Betterment, Vanguard Digital Advisor, or Wealthfront offer automatic rebalancing as part of their service. These tools use algorithms to monitor portfolios constantly and automatically execute trades when thresholds are exceeded. This hands-off approach is suitable for busy investors who still want a disciplined strategy and is often cost-effective.

Target-Date and Balanced Funds: For investors preferring a wholly managed approach, target-date and balanced mutual funds or ETFs come pre-packaged with built-in rebalancing strategies. These funds automatically adjust allocations to become more conservative as the target date (e.g., retirement) approaches. While convenient, they may lack customisation and can involve higher fees.

Tax-Aware Rebalancing: For those investing in taxable accounts, strategies that consider tax impact are crucial. Tax-aware rebalancing might involve prioritising asset sales that produce the least tax liability, such as harvesting losses to offset gains or selling long-term capital gains over short-term ones.

Cash Flow Rebalancing: Instead of selling existing assets to rebalance, investors can use new contributions (or withdrawals) to adjust allocation over time. For instance, if equities are overweight, new contributions can be directed toward underweight asset classes like bonds or cash, reducing imbalance naturally.

Rebalancing Tolerance Bands: This strategy involves allowing a set range or “band” around your target asset allocation. For instance, if a portfolio’s target is 60% equities, a tolerance band of ±5% means the equity portion can drift between 55% and 65% before rebalancing is triggered. This prevents excessive trading and minimises costs while managing risk.

Software and Tools: Many brokerages offer tools to facilitate rebalancing. Portfolio analysis platforms such as Morningstar, Personal Capital, or tools within trading platforms like Fidelity, Schwab, or Vanguard enable investors to track allocations and execute rebalances efficiently. These tools can simplify execution, especially when dealing with multiple accounts or tax considerations.

In professional asset management, rebalancing is deeply integrated into portfolio management strategies. Institutional investors employ sophisticated models analysing volatility trends, return expectations, correlation matrices, and scenario-based simulations to dynamically rebalance portfolios across global asset classes. Individual investors can tap into similar insights through financial planning software or by working with an adviser.

Whether handled independently or with the help of an adviser or robo-platform, having a clear rebalancing strategy is indispensable for long-term investment success. It ensures alignment with risk preferences, maintains financial discipline, and helps withstand emotional biases during market highs or lows.