This article explains a general investing concept for educational purposes. It is not personalised investment advice for your specific portfolio.
Even a carefully constructed portfolio, built with a deliberate, well-considered asset allocation, quietly drifts away from that intended allocation over time, simply because different asset classes grow at different rates. Rebalancing is the discipline of periodically bringing your actual holdings back in line with your intended targets, and it matters more than many investors initially realise.
How Drift Actually Happens
Say you start with a portfolio intentionally split 60% equity and 40% debt. If equity markets perform strongly over the following few years while debt returns remain more modest, your equity holdings could grow to represent 75% of your portfolio, with debt shrinking to 25%, purely due to differing growth rates, without you having made any active decision to become more aggressively allocated. Your portfolio is now meaningfully riskier than originally intended, a risk profile you didn't deliberately choose, but that emerged passively from market movements.
Why This Drift Genuinely Matters
The specific asset allocation you originally chose was presumably based on your goal's timeline and your own risk tolerance, as discussed in our asset allocation guide and risk tolerance guide. If your actual allocation has drifted well beyond this intended target without a deliberate decision to change it, you're carrying more (or less) risk than you actually decided was appropriate, which becomes particularly consequential if a significant market downturn occurs while your portfolio has drifted toward a considerably higher equity concentration than you'd genuinely intended.
The Two Main Rebalancing Approaches
Calendar-based rebalancing: Review and rebalance at fixed intervals, commonly annually, regardless of how much drift has actually occurred, this is simple and predictable, requiring no ongoing monitoring beyond the scheduled review date.
Threshold-based rebalancing: Review periodically, but only actually rebalance when an asset class has drifted beyond a specific predetermined threshold (commonly cited examples include a 5 or 10 percentage point deviation from target), this responds more directly to actual drift rather than an arbitrary calendar date, potentially triggering more frequent rebalancing during volatile periods and less frequent rebalancing during calmer ones.
How Rebalancing Actually Works in Practice
Rebalancing typically involves selling a portion of the asset class that has grown to exceed its target allocation, and using the proceeds to buy more of the asset class that has fallen below its target, bringing the overall portfolio back toward the originally intended split. For ongoing SIP investors, a lighter-touch alternative is directing new contributions disproportionately toward the underweight asset class, gradually correcting the drift through new money rather than needing to sell existing holdings.
Why Rebalancing Has a Built-In "Buy Low, Sell High" Discipline
A notable, often underappreciated feature of rebalancing is that it mechanically involves selling some of whatever has recently performed well (and consequently grown to exceed its target weight) and buying more of whatever has recently underperformed (and fallen below target), this is precisely the disciplined "buy low, sell high" behaviour that's genuinely difficult to execute purely through willpower and emotion in the moment, rebalancing provides a structured, rules-based way to actually follow through on this principle.
Tax Considerations When Rebalancing
Selling appreciated holdings to rebalance can trigger capital gains tax, as discussed in our capital gains tax guide, worth factoring into your rebalancing approach, sometimes achieving the same rebalancing effect through directing new contributions toward underweight assets (rather than selling overweight ones) can reduce the tax impact while gradually achieving a similar correction, particularly useful for taxable accounts where minimising unnecessary transactions has genuine value.
Rebalancing Across Different Account Types
If you hold investments across multiple accounts or platforms, considering your overall portfolio allocation in aggregate, rather than trying to maintain the exact target allocation within every single individual account separately, generally gives you more flexibility in how and where you execute the actual rebalancing trades, particularly useful for managing tax impact by choosing which specific account to trade within.
Frequently Asked Questions
How often should most individual investors actually rebalance?
Annual review, with rebalancing triggered only if drift exceeds a meaningful threshold, is a commonly used and reasonably practical approach for most individual investors, avoiding the complexity of overly frequent rebalancing while still catching significant drift before it becomes a substantial unintended risk shift.
Does rebalancing guarantee better returns than not rebalancing at all?
Not necessarily in every single period, since a portfolio that's drifted toward higher equity weight during a strong equity bull run would, in hindsight, have benefited from not rebalancing during that specific period. Rebalancing is primarily a risk management discipline, ensuring your portfolio's risk level matches your actual intended tolerance, rather than a strategy specifically designed to maximise returns in every scenario.
Should I rebalance during a significant market downturn, or wait until things stabilise?
A downturn in equity markets while debt holds steady would actually cause equity's weight to fall below target, meaning rebalancing during a downturn would involve buying more equity at lower prices, consistent with the disciplined approach discussed above, though this requires genuine discipline to execute when it can feel emotionally uncomfortable to be buying into a declining market.
Is there a cost-effective way to rebalance without triggering significant tax or transaction costs?
Using new contributions (fresh SIP amounts or lump sum additions) to correct drift by directing them toward underweight asset classes, rather than selling overweight holdings outright, is a commonly used approach that achieves gradual rebalancing with minimal additional tax or transaction cost, particularly effective for investors still in an active accumulation phase with regular new contributions.
