Portfolio rebalancing is the practice of buying and selling assets to return a portfolio to its target asset allocation after market movements have shifted the weights. When one asset class outperforms, it grows to a larger share than intended; rebalancing trims it and tops up the lagging classes. This enforces a disciplined "sell high, buy low" rule and keeps risk at the chosen level.
Worked example
Your target is 60% stocks and 40% bonds on a €100,000 portfolio. After a strong rally, stocks grow to €72,000 and bonds to €48,000 (a total of €120,000), making the split 60% by value but 60/40 only by chance — say instead stocks are €78,000 and bonds €42,000, a 65/35 split. To rebalance to 60/40 you sell €6,000 of stocks (to €72,000) and buy €6,000 of bonds (to €48,000).
Why it matters
Rebalancing matters because, left alone, a portfolio drifts toward whichever asset has risen most, quietly raising its risk above what you intended. The main pitfall is doing it too often: frequent trades trigger transaction costs and, in taxable accounts, capital-gains tax, so most investors rebalance on a schedule (e.g. annually) or only when an allocation drifts past a set threshold.
Frequently asked questions
There is no single right answer, but a common approach is once a year, or whenever an asset class drifts more than about 5 percentage points from its target. Less frequent rebalancing keeps costs and taxes low.
Its main purpose is to control risk rather than boost returns. By trimming winners and adding to laggards it can modestly improve risk-adjusted returns, but it should not be relied on to beat the market.