Rebalancing

Once you have set an asset allocation, markets will move it. If shares rise faster than bonds, shares become a larger slice of the portfolio than you intended, and the portfolio becomes riskier. Rebalancing restores the target by selling some of what has grown and buying what has lagged, or, more cheaply, by directing new contributions or withdrawals towards the underweight asset. Common approaches are to rebalance on a fixed schedule, such as once a year, or whenever an asset drifts beyond a set band, such as five percentage points from its target.

The main purpose of rebalancing is risk control, not extra return: it keeps the portfolio’s risk in line with what you chose. It also imposes a useful discipline, since it means trimming what has done well and adding to what has fallen, the opposite of what emotions suggest. The costs are trading fees, spreads and, outside tax-sheltered accounts, possible capital gains tax, so rebalancing too often can do more harm than good. There is no single best frequency.