Rebalancing is the disciplined act of returning your portfolio to its original target asset allocation. It forces you to do what feels unnatural: sell high and buy low.
Why Rebalance?
Imagine you start with a 60% Equity / 40% Bond portfolio. Over a three-year bull market, your equities grow rapidly while bonds remain flat. Your portfolio might drift to 75% Equity / 25% Bond.
If the market crashes the next day, you will suffer significantly more losses than you originally planned for, because your risk profile drifted upwards. Rebalancing returns you to 60/40, locking in equity gains and buying more bonds while they are relatively cheap.
When to Rebalance
- Time-based: Check once a year on a set date (e.g., your birthday).
- Threshold-based: Check quarterly, but only act if an asset drifts more than 5% from its target.