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How to rebalance your portfolio

I have previously discussed why rebalancing your portfolio is a good idea. In short, by reducing or adding to your holdings in different asset classes, you can smooth your returns and keep risk within a level you can tolerate.

How do you actually do it? Well, rebalancing is definitely an art more than a science.

We’ve talked before about how there are no rules for constructing the perfectly diversified portfolio – unless you believe in utterly efficient markets AND you know yourself better than a Zen master and so can anticipate your reaction to any kind of market conditions!

Equally, there’s no perfect method of rebalancing. But there are definitely factors you should keep in mind.

Hence this series on how to go about rebalancing your portfolio.

Make sure you’ve read that first post on why you should rebalance, and please do subscribe or bookmark this site to get the rest of the series.

For the rest of this article, we’ll discuss the crucial decision you must make before rebalancing.

Remember, your own best course of action will depend on your circumstances, the trading platforms you use, whether you hold assets in pensions and so on, so do get proper advice if you need it. I’m not an advisor!

1. Asset allocation is the number one aim when rebalancing

Rebalancing works when you have a firm asset allocation plan you want to stick to. For example, you might have decided the best mix of assets for you is:

  • 30% Domestic Equities
  • 10% Foreign Equities
  • 10% Emerging Equities
  • 10% Small cap Equities
  • 5% Commercial Property (REITs)
  • 5% Corporate bonds
  • 10% Index Linked (inflation proofed) Government bonds
  • 10% Fixed income government bonds (Gilts or US treasuries)
  • 10% Cash in savings

Knowing that index tracking funds are the cheapest, best way to get long-term exposure to equities, you could invest in each equity class via ETFs or tracker funds.

You could then use investment trusts and funds or ETFs to put the appropriate percentages into high grade corporate bonds and government bonds.

Over time, different assets will deliver varying returns, moving your ideal allocations out of shape.

To rebalance your portfolio, you would trim holdings of the better performing asset classes by selling a proportion, and put the proceeds into underweight asset classes, in such a way as to set your portfolio back to your chosen allocations.

Rebalancing is automatically contrarian

Think about what this rebalancing will entail in practice. You’ll be selling an asset that is doing really well, to put money into one that is probably doing badly!

The idea is that over the long-term you’ll benefit from investing more in out-of-favor assets, as well as keeping volatility under control.

But at the time you’ll probably feel pretty queasy – you’re being asked to bet against the market and popular opinion when you rebalance.

If you don’t know your asset allocation in advance – and why you’ve chosen it – then in the face of such emotions, rebalancing is likely to become an exercise in speculation. So make sure you’ve firmly decide on (and believe in) your asset mix before you start to tweak it.

Incidentally, I don’t believe you need to worry about rebalancing down to the nearest percentage point. Life is too short, and trading too costly. Keeping things roughly in balance is the aim.

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{ 11 comments… add one }
  • 1 PC May 31, 2013, 1:15 pm

    I accept that rebalancing is a good idea but it conflicts with my other rule of thumb to keep winners and sell losers, or relative losers.

    Perhaps the problem is that I don’t have a firm belief in my asset mix and I don’t think there’s an easy answer to that, the exact mix is not easy to determine with any precision.

    Bit of a conundrum ..

  • 2 The Investor May 31, 2013, 8:50 pm

    @PC — Well, rebalancing is more about asset classes than about individual equities. It’s been shown to improve returns by various degrees over most investing time frames. In contrast, I’ve never seen the research but I’m sure that a policy of selling winners and buying losers would not make you money, as you suggest.

    There’s definitely no exact perfect allocation, or more than rough rules of thumb. It may help to remember that rebalancing is as much about risk reduction and reducing the maximum volatility, too. Your best shot at the best theoretical returns are to hold a portfolio entirely made up of small cap value shares or similar, but it will also be the roughest ride possible to endure. Most of us need the spikes smoothed out to some degree or another!

  • 3 Barry October 4, 2013, 9:09 pm

    Remember that the goal is to sell high and buy low. So, if you have an asset allocation mix that you believe in, then the winners and losers will skew the mix. Thus, periodically rebalancing to achieve the asset allocation provides a handy way to invest more dollars into those assets that are relatively “cheaper” and have more upside potential while taking profits off the table from those that did well. I think we all have trouble selling high and buying low, but to me this provides a rational way of making myself do it.

    A problem is “when” to rebalance. Most say, “not often” but what does that mean? Monthly? Semi-annually? Yearly? I’ve read one writer whom I respect who advises to do it at each Presidential election, using that more as a reminder that he does it every four years. There is no correct answer. I think it depends more on how out of balance the asset mix becomes, since you don’t want transaction costs to add up too much.

  • 4 David Diprose October 6, 2013, 9:21 am

    Since being made redundant 17 years ago I have been forced to live off my investments – guys over 50 without a network cannot get a decent job in ageist Britain! I do funds because I do not have the wherewithal to do individual shares. I believe day-trading is a total gamble.
    For the last decade this is the system I have used. I track about a dozen funds – it fills my Saturday mornings – and I go with no more than three that I like the most. The dozen funds are widespread and tell me which sector to concentrate on. Then, generally, I hold just one fund (why hold more?). Hargreaves Lansdown has given me excellent service. I held Gartmore China Opps the year it went up by 80% and Marlborough Special Sits the year it doubled. I sat with JPMorgan Natural Resources too long into the recession but got a good lift from Aberdeen Emerging Markets. This summer it took me two months to spot the Aberdeen downturn (it is difficult to react more quickly than that, and I prefer to be late than early) and I an now holding Cazenove UK Smaller Cos. At the moment almost everywhere is flat because of the idiots in America but I am watching and waiting. Neptune UK Mid Cap, SLI UK Equity Unconstrained and Cazenove European look promising. I am hoping that Baring German Growth will do something but I am put off by the currency aspect. I would love to know what others think.

  • 5 Oldie January 31, 2014, 5:15 pm

    I take your point that you don’t need to calculate the asset allocations down to the exact percentage point when re-balancing; but when your portfolio has more than the barest minimum of 2 asset classes, it really makes it convenient to build a spreadsheet to assist you in calculating how much to spend on each class when you’re making your annual or other regular contribution to bring back to balance, or possibly, how much you may need to sell/buy of each class, if the unbalancing has gone really far off.

  • 6 Andrew Hallam February 9, 2014, 11:13 am

    Investor, you are overcomplicating the process and, dare I say, attempting to time the market. This process is, in fact, very very simple. I keep my portfolio somewhat balanced between stocks and bonds, with (currently) 40 percent in bonds and 60 percent in stocks. When stocks fall, to keep my 60 percent allocation, I add fresh money to my stock indexes. When stocks rise, I add to my bond allocation, to keep the portfolio split 60/40.

    When the markets exhibit manic depressive behaviours, as they did in 2003, 2008/2009, June 2010, August/September 2011 and April 2012, then I’m forced to rebalance by selling some of my “winners” to buy some of my “losers”. All I’m trying to do is keep my portfolio as close to my target allocation as possible.

    Assetbuilder, a financial service company, rebalances portfolios of indexes for their clients. Three of their model portfolios would have made more than 200 percent over the past decade. These aren’t single funds that I’m singling out. They’re diversified portfolios, rebalanced with regular dispassion.

    Unemotional rebalancing is a simple way to make loads of money when the markets are volatile.

    But it’s not psychologically easy for people to do. To do so, you must ignore the financial media; ignore economic forecasts; and ignore your natural instincts. Neither of the three is likely to encourage you to do anything useful.

  • 7 The Investor February 9, 2014, 1:25 pm

    @Andrew — For someone who says he doesn’t mean his comments to be aggressive, you do come across as (politely, certainly!) confrontational.

    I am not over-complicating the process. There is absolutely no consensus as to the right way to rebalance. The historical data is inconsistent, and the future unknowable. Costs vary for different investors, as does motivation and stomach for volatility. Over some periods of time, rebalancing over 5-10 years will prove advantageous, while at other times massive funds have added value with tiny daily rebalancing, which is obviously out of the reach for the likes of us.

    As for market timing, Ben Graham, the father of modern security analysis and a far better and more influential investor than I or I dare say you will ever be, was completely at ease with shifting allocations depending on market sentiment. (From a minimum of 25% in equities to a maximum of 75% in equities, with the balance on bonds, depending on market conditions).

    The introductory article above explicitly cites one of the benefits of rebalancing as that it adds to underperforming assets and that it’s contrarian.

    Everything you write after you initial salvo is perfectly reasonable and it obviously worked for you and would work for others, but it’s one way, not the only way, and not definitively proven to be the best way.

  • 8 Paul S April 22, 2014, 1:14 am


    I spent most of the 2000’s trying to figure out what a portfolio should look like on spreadsheets. The uncertainty played a massive part in my failure to actually invest serious real cash in anything other than punts…

    I think you just have to have a conviction and go with it. but after reading this I will seriously look at asset classes across the ISA’s and SIPP’s etc. rather than just per wrapper…

    ( as an example I created a fantasy portfolio in 2000 after I had started using amazon.co.uk, that was based on the hypothesis that the internet would ‘take off’ big style and any real bricks and mortar company that had a significant ‘play’ in logistics and distribution would make stacks of cash…the folio even included stocks such as GUS! – my, how I wish I had followed this conviction!)

    After getting burnt by dotcoms (telewest) and banks (Lloyds/RBS) I just frankly gave up on any ability I may have deluded myself that I have in timing or tracking the market and decided just to invest chunks of cash according to my convictions… and not care a damn about checking on the market. If it all goes arse up…. I’ll be in no worse position than in most of the decade of the 2000’s so what the hell…but just maybe I will be better off.

    Here is the good…..

    1. I have a significant chunk of corporate bonds bought in the very late 2000’s. These are fab they pay excellent interest (up to 7.6%) I get all the money back that I invested by letting the bonds run to full term of up to 21 years from now..(in some cases I get more back as the bonds were way, way cheap) I protect the money in an ISA and use the interest to either buy more bonds or…

    2. I have a chunk of investment trusts in a mix of emerging markets, UK and foreign equity areas…..this is my sop to wanting to understand a asset class and sector and putting cash where my convictions are (in ISA and SIPP)

    3. I have index trackers for sectors and markets that I don’t fully understand, or care too!, but believe I should have exposure to because they help me diversify and access growth potential (e.g. S&P 500 – don’t understand it, know I need to be in the US market)(in ISA and SIPP)

    4. I still follow the odd strange conviction….I have some Investec Natural Resource IT’s bought every month, because they hold a mix of real world companies like BHP and Shell and Xstra (not commodities, but the companies who generate the commodities) and I believe that’s where the money will be in 20yrs time, and the IT cost is very, very cheap at the moment…. (I had BHP shares in 2000 ish, sold at 465p and wish I still had them now 😉 … I thought I could time the market!

    The ugly….

    I have a company pension scheme where I invest in pension-ised OEIC’s & IT’s and blended fund of fund of funds (or whatever) – the range is limited, the best performing fund over 10 yrs is only placed 76 in the list of the OEIC/IT universe and when the ‘men in suits’ put the stuff inside a pension wrapper, wow more charges and less returns than the fund clean in my ISA or SIPP (grrrrr…… I asked the gov. MUM folks why this was…..silence on the line LOL)…

    But!! – for every £1 I pay in (up to a fair % of salary) the company pays in a £1 too! so a 100% return the day the cash goes in….. BANG! – when I leave, or I am sacked or whatever, I’ll yank the cash into my SIPP and do it properly….

    Now after reading this article, must get serious about a asset strategy and rebalance!

    Paul S

  • 9 Tom February 14, 2015, 11:40 am

    Surely rebalancing should be completed on a % away from target basis?
    E.g if my target is a 60/40 split, and equities rise faster than bonds then I rebalance at 65\35 or at 55/45 if it goes the other way?

    The time frame doesn’t seem important here, but the variance.

    The same would apply on more complex portfolios as per the main article. The tolerance on a 10% holding could be +\- 2% for example.

    Just a thought…

  • 10 Chris Reid March 3, 2015, 8:50 am

    I am a novice investor, so please if you disagree with my thoughts, do so without arrogance.
    My understanding for portfolio re-balancing seems to be less of a hard and fast rule for everyone, and more of an art form, as everyone’s case may be different. Your asset allocation will be changing all the time, with the volatility of the market. The larger the amount you have invested, the more you can afford to re-balance regularly, since transaction fees will eat up less of your returns, and it depends on whether your re-balancing consists of of purchasing new investments with cash, or selling existing investments, and re-purchasing.
    If you are simply buying new investments regularly with existing cash, it makes sense to use that cash to re-balance as much as possible on a more frequent basis than you would be selling investments and re-purchasing.

    It seems more about having a plan that you can stick with than necessarily there being a “correct” one. I have heard a rule of thumb to re-balance when your investments get 5% away from your target allocation or 25% of the investment value – whichever is greater. i.e. if I have an investment that is initially 5% of my portfolio allocation, I would re-balance when it reaches either 0% or 10%, but if I have an investment that is 35% of my asset allocation I would re-balance this when this reaches either 26.25% or 43.75%. But since my my portfolio is only $50,000, to save on transactions costs, I would do this re-re-balancing every 6 months. But if I have a $1 million portfolio, I might be re-balancing on a monthly basis, since my transaction cost will be a tiny proportion of the total performance of the investment.

  • 11 The Investor March 3, 2015, 1:46 pm

    @Chris — Hi, I agree with pretty much all of your comments. Indeed if you read through the rest of the articles in the series you’ll see that.

    Definitely no firm rules to rebalancing — and you can only know what would have been the best strategy in hindsight.

    One thing you don’t mention is tax. Rebalancing strategies should only be sensibly implemented once you have also taken tax in mind, and ideally only undertaken inside tax-sheltered accounts, like ISAs and SIPPS here in the UK.

    Paying capital gains taxes for churning your portfolio will reduce your returns! 🙂

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