Dynamic allocation and rebalancing

A portfolio set today does not stay where you put it. As prices move, the winners grow into a larger share and the losers shrink, so the mix drifts away from your target. Rebalancing is the act of restoring it.

Why drift is dangerous

Suppose you start at 60 percent stocks and 40 percent bonds, and equities rally hard. You might wake up at 75/25 without making a single trade. Your portfolio is now far riskier than you chose — and you took on that extra risk passively, by neglect, at exactly the moment stocks are most expensive.

Rebalancing as disciplined contrarianism

Rebalancing back to target forces a healthy behavior: you sell what has risen and buy what has fallen. It is automatic "buy low, sell high", executed by rule rather than emotion, and it keeps your risk level constant rather than letting the market dictate it.

Drifted to 75 / 25 -> sell stocks, buy bonds -> back to 60 / 40

The two common methods

• Calendar rebalancing: realign on a fixed schedule — quarterly or annually. Simple and predictable.
• Threshold (band) rebalancing: realign only when an asset drifts beyond a tolerance band, say plus or minus 5 percentage points. More responsive, fewer needless trades.

Many investors combine them: check on a schedule, but trade only if a band is breached.

The cost trade-off

Rebalancing is not free. Every trade incurs costs and, in a taxable account, can trigger capital-gains tax. Rebalance too often and these frictions eat the benefit; too rarely and you let risk drift unchecked. The sensible middle is infrequent, rule-based rebalancing with reasonably wide bands.

The deeper caveat

Rebalancing assumes assets are mean-reverting — that today's loser will tend to recover. When an asset is in a genuine, permanent decline, rebalancing means repeatedly throwing good money after bad. The discipline is powerful precisely because it removes emotion, but it is not a substitute for occasionally re-examining whether the strategic allocation itself still makes sense.