Rebalancing your portfolio

Rebalancing does not make you richer. That is the first thing to accept, because almost every article about it promises the opposite. What rebalancing does is keep the risk in your portfolio equal to the risk you actually chose, and it is the only maintenance task in investing that takes twenty minutes a year.

Here is the arithmetic, using numbers rather than adjectives. You start with $100,000 in a 70/30 stock-bond portfolio. Stocks return 7.5% a year, bonds 2.5%. After ten years you have $181,023, and your stock weight is 75.5%: the 70/30 portfolio you deliberately chose is now a 75/25 portfolio you never agreed to. After twenty years the stock weight reaches 83.4%.

Now the part nobody advertises: rebalancing that same portfolio every year cost you money. It ended at $180,690 instead of $181,023, about 0.02% a year given up. In a year when stocks fell 25% and bonds rose 3%, the unrebalanced portfolio dropped to $78,153 while the rebalanced one held at $79,750. Rebalancing is insurance with a small premium.

Drift is not a small problem

A 5.5 percentage point drift sounds like a rounding error until you price it. If stocks fall 35% from here, the drifted portfolio loses $52,404 and lands at $92,126. Restoring 70/30 at that moment means moving $15,847 out of bonds and into a market that is still falling. That is the trade, and it is the reason to write the rule down while you are calm rather than negotiate with yourself while you are frightened.

Anyone with a two-decade horizon and a high risk tolerance should drift, not rebalance. If you are 30 and your plan is 100% equities, there is nothing to rebalance and no point pretending otherwise.

Two numbers decide everything

A rebalancing rule has a trigger and a method. Get these wrong and you will spend real money to stay exactly as exposed as you already were.

A 10-point band on a $100,000 portfolio demands a $15,800 trade to fix. Someone saving $475 a month cannot close that with contributions inside a year. A 5-point band needs about $5,300, which the same saver fixes in eleven months without selling anything. That is why the band size has to match your savings rate, not your taste for precision.

Fix the drift with new money first

Selling to rebalance is the method of last resort, because every sale is a taxable event in a regular brokerage account. Long-term capital gains are taxed at 0%, 15% or 20% depending on income; 15% is the common middle-income rate. If your whole portfolio sits in a taxable account and you are in a high bracket, sell less than you think you should.

Chase the drift with contributions instead. Three years of a plain 70/30 portfolio at the same returns put you at $124,484 with stocks at 72.5%. Directing the next twelve months of savings into bonds alone pulls that weight back to 69.8%. Nothing was sold, no gains were realised, and the correction cost one change to a standing order.