What is rebalancing?

Rebalancing means bringing a portfolio back to its intended mix of investments after market movements have pushed it away. If a portfolio is meant to hold 60% stocks and 40% bonds, a strong stock market can shift it to 70/30 without a single trade. Rebalancing sells some of what has grown and buys some of what has lagged, restoring the 60/40 — and with it the level of risk that was chosen.

Measuring the drift

The drift of each part of the portfolio is its actual weight minus its target weight:

d_k = w_k^{\text{actual}} - w_k^{\text{target}}

and the amount to trade to restore the target is:

\Delta V_k = (w_k^{\text{target}} - w_k^{\text{actual}}) \times V_{\text{total}}

A positive amount is a purchase; a negative one is a sale.

A simple illustration

A €100,000 portfolio starts at 60% stocks and 40% bonds. Over a year, stocks rise 25% and bonds stay flat:

	Start	After a year	Weight	Target	Trade
Stocks	€60,000	€75,000	65.2%	60%	−€6,000
Bonds	€40,000	€40,000	34.8%	40%	+€6,000

The portfolio is now worth €115,000. Restoring 60/40 means selling €6,000 of stocks and buying €6,000 of bonds.

Common methods

Calendar rebalancing. Once or twice a year, whatever the drift. Simple and predictable.
Threshold rebalancing. Only when a weight moves beyond a band, for example more than 5 percentage points from its target. It trades less often, and only when it matters.
Rebalancing with cash flows. New savings go to whatever is under-weight, and withdrawals come from whatever is over-weight. This rebalances without selling, which avoids fees and taxes.

What it does

It controls risk. Left alone, a portfolio drifts toward its riskiest part, because that part usually grows fastest. Over decades, a 60/40 portfolio can become 80/20 or more.
It enforces discipline. It systematically sells after rises and buys after falls — the opposite of what investors tend to do by instinct.
It is not mainly a return booster. In long, steady bull markets rebalancing slightly lowers returns by trimming the best performer. Its purpose is to keep risk where it was chosen.

Costs to weigh

Every sale can trigger transaction costs and, outside tax-sheltered accounts, capital gains tax. Rebalancing too often spends money on small corrections; wider bands and the use of new cash flows keep the costs down.

See these numbers for your own portfolio

Floreo works out every figure on this page from your own holdings — returns, risk, allocation, currencies — and the assistant explains them the way this page does. Import from your broker, or try it on the sample portfolio first.

Start Demo

The demo opens straight away on a sample portfolio — no account needed.