What is rebalancing?

Rebalancing is a core idea in portfolio management. It means bringing your portfolio back to the risk allocation you originally chose after markets have moved.

For example, if you start with:

  • 60% stocks
  • 40% bonds

…then different returns over time will change the mix. Stocks may end up taking a larger share, and bonds a smaller one — without you making an intentional decision.

Rebalancing means adjusting back to 60/40.

Rebalancing isn’t an attempt to predict the market — it’s risk control.

Why does the portfolio drift on its own?

Markets don’t move evenly. In some periods stocks do much better than bonds; in other periods it’s the opposite.

If you don’t rebalance, the portfolio gradually drifts toward whatever has performed best recently. That usually means:

  • risk slowly increases in good times
  • losses become larger when the market turns

Often this happens without the investor noticing.

Illustration 1: The portfolio drifts over time

Portfolio allocation before and after market movesIllustration of how a 60/40 portfolio can drift toward a higher stock share without rebalancing.StartAfter market moveStocksBonds

Without rebalancing, the best-performing asset class grows, and the portfolio becomes riskier over time.

What do you gain by rebalancing?

1. Risk stays (roughly) constant

When you rebalance, you help ensure the portfolio keeps reflecting your risk tolerance — not the market’s mood.

That means:

  • less risk of unexpectedly large losses
  • a higher chance you’ll stick to the strategy

2. Rebalancing creates discipline

Rebalancing forces you to do something that often feels wrong:

  • sell some of what has gone up a lot
  • buy some of what has lagged

That’s emotionally difficult, but strategically strong. The process is mechanical and independent of headlines and sentiment.

3. Better risk-adjusted outcomes

Rebalancing isn’t mainly about maximizing returns. It’s about improving the trade-off between return and risk.

Historically, rebalanced portfolios have often:

  • had lower volatility
  • experienced smaller drawdowns
  • produced a more stable long-term journey

Illustration 2: Same outcome — different experience

Rebalanced vs non-rebalanced portfolioTwo portfolios with the same long-term result, but different volatility along the way.RebalancedNot rebalanced

Two portfolios can end up in the same place — but rebalancing often creates a calmer ride on the way there.

How often should you rebalance?

There are two classic approaches:

  1. Time-based

    • e.g., once per year
    • simple and predictable

  2. Threshold-based

    • e.g., if an asset class deviates by more than 5 percentage points
    • more precise risk control

Many investors use a combination.

Rebalancing isn’t free

In theory, rebalancing is often assumed to be frictionless. In practice, there may be:

  • trading fees
  • spreads
  • practical constraints

That means the “optimal” rebalancing frequency in real life is often lower than in academic models.

Theory vs reality

Rebalancing is a powerful tool for risk control and discipline. But classic theory often assumes an ideal setup without frictions.

In real life — and especially in some countries — taxes and account rules can make rebalancing more complicated than the theory suggests.

In the article Rebalancing vs. Danish Taxation we look more closely at why rebalancing isn’t always optimal in Denmark — and how to adapt the strategy in practice.

Short summary

  • Rebalancing helps keep risk stable over time
  • It prevents the portfolio from drifting in one direction
  • It creates discipline and reduces emotion-driven decisions
  • It often creates a more stable long-term investing experience
  • But theory and practice are not always the same

Rebalancing isn’t a trick. It’s basic portfolio management.