What Is Rebalancing?

Rebalancing is the process of restoring a portfolio's asset allocation to its original target after market movements have caused it to drift. For example, if you start with a 60% equity / 40% bond split and a strong equity rally pushes equities to 70%, you are carrying more risk than intended.

For further reading, books analyzing the rebalancing effect can help you see, in concrete numbers, how periodic adjustments affect returns.

Rebalancing involves selling a portion of the appreciated asset (equities) and buying more of the relatively underweight asset (bonds) to restore the original 60:40 ratio. This automatically enforces the investment principle of 'sell high, buy low.'

Quantifying the Rebalancing Effect

Research by Vanguard shows that a portfolio rebalanced once a year reduces risk (standard deviation) by roughly 2-3% while improving returns by about 0.3-0.5% per year compared to a never-rebalanced portfolio.

Consider a concrete example. A 60% equity / 40% bond portfolio starting with 1,000 man-yen over 20 years (assuming 7% equity return and 2% bond return): without rebalancing, the equity share eventually reaches about 80%, dramatically increasing risk. With annual rebalancing, the final asset value is nearly the same, yet the maximum drawdown is reduced by approximately 15% according to simulation results.

Calendar Rebalancing vs. Threshold Rebalancing

There are two main approaches to rebalancing.

  • Calendar rebalancing: Review and adjust your allocation at fixed intervals - annually or semi-annually. Simple and easy to execute, this is the most recommended method for individual investors. Setting a memorable date such as January 1st or your birthday helps ensure consistency.
  • Threshold rebalancing: Adjust whenever the drift from the target exceeds a set threshold (e.g., 5%). This responds quickly to sharp market moves but requires frequent monitoring. A hybrid approach - 'once a year plus whenever drift exceeds 5%' - combines the strengths of both methods.

Leveraging No-Sell Rebalancing

No-sell rebalancing corrects allocation drift by directing new contributions or dividends toward underweight asset classes, rather than selling overweight ones. For example, if equities are above target, you concentrate the next month's contributions into bonds, avoiding the taxes and fees associated with selling.

This technique is especially valuable in a NISA account, where selling consumes your tax-free allowance. If your monthly contributions are large enough, no-sell rebalancing alone can often keep drift within 1-2%. Try our simulator to compare your target allocation with your current holdings and assess whether rebalancing is needed.

Books on rebalancing methods can walk you through the specific steps and show you how to minimize costs.