What Is Portfolio Rebalancing in the Stock Market and Other Markets?

Portfolio rebalancing is the process of periodically adjusting the asset allocation in an investment portfolio back to its original target percentages. Over time, as different investments perform differently, the portfolio’s mix drifts away from the intended balance—some assets grow to represent a larger portion, while others shrink. Rebalancing involves selling portions of outperforming assets and buying more of underperforming ones to restore the desired proportions.

This practice is widely used in personal investing, retirement accounts, pension funds, endowments, and institutional portfolios across various asset classes, including stocks, bonds, real estate, commodities, and even alternatives like private equity or cryptocurrencies. This article is not for financial advice but for informative purpose only.

Why Portfolios Drift

Different asset classes and individual securities have varying returns, volatilities, and correlations. Over time, this causes natural drift:

In a bull market, stocks may grow faster than bonds → stock allocation rises.
During a bond rally (falling yields), fixed-income holdings increase in value relative to equities.
In a commodity boom, energy or metals exposure grows disproportionately.

Without rebalancing, a portfolio that started as 60% stocks / 40% bonds might become 75% stocks / 25% bonds after a strong equity run—changing its risk profile significantly.

How Rebalancing Works

There are two main approaches:

Time-Based Rebalancing

Review and adjust at fixed intervals (e.g., annually, semi-annually, quarterly).
Simple and predictable; common for long-term investors.

Threshold-Based (or Band) Rebalancing

Rebalance only when an asset class deviates by a certain percentage from its target (e.g., ±5% or ±10%).
More responsive to market moves; reduces unnecessary trading.

Many investors use a hybrid: check periodically but only act if drift exceeds a threshold.

Rebalancing can be done by:

Selling overweight assets and buying underweight ones.
Adding new cash to underweight areas.
Directing new contributions or dividends toward lagging allocations.

Role and Benefits of Rebalancing

Rebalancing serves several key purposes:

Risk Control
Maintains the intended risk level. A drifted portfolio may become much more aggressive or conservative than planned.
Discipline
Forces investors to “sell high, buy low” systematically—countering emotional tendencies to chase winners or avoid losers.
Potential Return Enhancement
In mean-reverting or cyclical markets, rebalancing captures gains from outperformers and adds to underperformers, potentially improving long-term returns (though not guaranteed).
Alignment with Goals
Keeps the portfolio consistent with the investor’s risk tolerance, time horizon, and objectives.

Rebalancing in Different Markets and Asset Classes

Stock Market (Equities)

Most common application: Rebalancing among sectors, styles (growth vs. value), market caps (large vs. small), or geographies.
Example: A portfolio with 60% U.S. stocks / 40% international drifts to 70/30 after strong U.S. performance → sell U.S. holdings, buy international.

Bond / Fixed Income Markets

Rebalancing between short-term vs. long-term bonds, credit quality (investment-grade vs. high-yield), or duration exposure.
Interest rate changes can cause significant drift (bond prices move inversely to yields).

Multi-Asset Portfolios

Classic 60/40 (stocks/bonds) portfolio is rebalanced to maintain the target split.
Increasingly includes alternatives: real estate (REITs), commodities, or inflation-protected securities.

Real Estate (Direct or REITs)

Rebalance across property types (residential, commercial, industrial) or geographies.
REIT portfolios often rebalance to maintain sector exposure (e.g., retail vs. data centers).

Commodities

Rebalance among energy, metals, agriculture, or precious metals to maintain desired inflation-hedge or diversification profile.

Cryptocurrencies (in diversified portfolios)

Rebalance between Bitcoin, Ethereum, and altcoins to control exposure to high-volatility assets.

Practical Considerations

Frequency: Too frequent increases transaction costs and taxes; too infrequent allows excessive drift.
Taxes: In taxable accounts, selling winners triggers capital gains tax; tax-efficient methods (new contributions, tax-loss harvesting) help.
Costs: Trading fees, bid-ask spreads, and market impact matter more in illiquid assets.
Automation: Many robo-advisors, target-date funds, and index funds rebalance automatically.

Modern Context

In the 2020s, sector rotation (tech dominance 2020–2021, energy/financials 2022, AI-driven tech again 2023–2026) has made rebalancing more impactful. Low interest rates (pre-2022) favored growth stocks; rising rates shifted favor to value and cyclical sectors, forcing many portfolios to rebalance significantly.

Rebalancing is a disciplined, mechanical process used to maintain a portfolio’s intended risk-return profile as market movements cause natural drift. It is a cornerstone of many long-term investment approaches across stocks, bonds, real estate, commodities, and alternative assets, helping keep allocations aligned with goals despite changing market conditions.