Definition
Portfolio rebalancing is the periodic act of trading positions back toward a pre-declared target allocation after differential returns cause the actual weights to drift. If a 60/40 stock/bond portfolio rallies into 70/30 during a bull market, rebalancing trims stocks and buys bonds until the weights match the policy again. The exercise is mechanical by design: the policy was set when emotions were calm, and the rebalance enforces it when emotions are not.
Rebalancing comes in several forms. Calendar rebalancing acts on a fixed cadence — monthly, quarterly, annually. Threshold rebalancing acts only when a weight drifts beyond a tolerance band, say five percentage points from target. Hybrid policies combine the two. Each form trades operational simplicity against transaction-cost efficiency, and each is a hedge against the same failure mode: letting a winning bet quietly become a concentrated bet without anyone deciding it should.
Why it matters
How it works
The mechanics are simple but the trade-offs are not. At the rebalance moment, compute the current weight of each asset, compare it to the target, and submit trades that close the gap — net of transaction costs, taxes, and the bid-ask spreads on the assets involved. Threshold bands raise the bar for action so the portfolio is not churning on small drift; calendar dates lower the operational burden so rebalances happen even when nobody is watching.
The cost side of rebalancing is real. Each trade pays a spread, possibly commissions, and in taxable accounts realizes capital gains that would otherwise compound untaxed. The benefit is a combination of risk control and a small return premium that emerges when uncorrelated volatile assets are systematically pruned at highs and topped up at lows. For most allocators the right policy is the one cheap enough to follow through a full market cycle without drift toward "just one more day."