Rebalancing

Level 3 · Advanced⚙ Method

German termRebalancing

Read firstDiversification

Deep divesETF — Exchange-Traded Funds

Rebalancing is the practice of periodically buying or selling portions of a portfolio to bring its asset allocation back to a target mix. Asset classes grow at different rates, so a portfolio that starts at 70% equities and 30% bonds drifts over time; rebalancing sells some of what grew and buys more of what lagged, restoring the original ratio instead of letting the fastest-growing part take over the portfolio's risk profile.

Why it matters

Diversification sets a target mix of assets that don't all move together; rebalancing is what keeps that mix from silently drifting into something the investor never chose. Without it, a portfolio's risk level creeps upward during a strong market — equities compound faster than bonds, so the steadier portion shrinks exactly when a downturn would hurt most. Rebalancing is a mechanical discipline: it requires no prediction of which asset performs better next, only maintaining a ratio decided in advance.

The method

1. Set a target allocation — a fixed ratio between asset classes or funds, for example 70% equities and 30% bonds.
2. Check current values against the target — after a set interval (annually is common), calculate what share each holding actually represents.
3. Compare the drift to a trigger — either a fixed calendar schedule (once a year) or a deviation threshold (an illustrative 5 percentage points off target), whichever the investor committed to in advance.
4. Sell the overweight portion and buy the underweight portion — or, where possible, direct new contributions toward the underweight asset instead of selling, to reduce transaction costs and any capital gains tax a sale would trigger.
5. Repeat on the same schedule or threshold, consistently, regardless of which direction the market moved.

Worked example

An investor starts with €10,000 split 70/30 between an equity ETF (Exchange Traded Fund) worth €7,000 and a bond ETF worth €3,000. After a year of strong equity returns, the equity holding grows to €8,500 while the bond holding rises only to €3,100, for a total of €11,600 — a mix now near 73% equities and 27% bonds.

To rebalance back to 70/30, the target equity value is €11,600 x 0.70 = €8,120, and the target bond value is €11,600 x 0.30 = €3,480. The investor sells €8,500 - €8,120 = €380 of the equity ETF and buys €3,480 - €3,100 = €380 of the bond ETF, restoring the original ratio.

Holding	Before rebalancing	Target (70/30 of €11,600)	Action
Equity ETF	€8,500 (73%)	€8,120 (70%)	Sell €380
Bond ETF	€3,100 (27%)	€3,480 (30%)	Buy €380

Rebalancing with new money instead of selling. The mechanism does not have to be sell-and-buy. If contributions arrive regularly — through a Sparplan (automatic savings plan), for instance — directing that month's money entirely into the underweight asset until the ratio closes reaches the same target without selling anything. This buy-only approach, sometimes called cash-flow or contribution rebalancing, avoids both transaction costs and the capital-gains tax a sale would trigger. In a monthly setup it can hold a portfolio near its target continuously, with actual selling reserved for the rare drift too large for redirected contributions to correct on their own.

Check yourself

A portfolio has a target allocation of 60% equities and 40% bonds. It currently holds €13,200 in equities and €4,800 in bonds (total €18,000). How many euros of equities must be sold to restore the 60/40 target?

Which of these best explains why a portfolio needs rebalancing over time even if the investor changes nothing?

Asset classes grow at different rates, so a fixed starting ratio (like 70/30) drifts away from the target as one part outgrows the otherRebalancing exists to predict which asset class will outperform in the coming year and shift money into it earlyFund providers require investors to trade periodically or the fund is closedInflation erodes the euro value of both equities and bonds equally, so periodic buying restores purchasing power

Which of the following are true about rebalancing? (Select all that apply.)

New contributions can sometimes be directed entirely to the underweight asset instead of selling the overweight one, reaching the same target allocationSelling an appreciated holding to rebalance can trigger capital gains tax on the amount soldRebalancing guarantees a higher return than leaving the portfolio untouchedA rebalancing rule can be based on a fixed calendar schedule or on a deviation threshold, decided in advance

A household spreads €20,000 across 10 different companies at 10% each. A year later, without any trading, some holdings have grown more than others. What best distinguishes diversification from rebalancing in this scenario?

Diversification was the initial spread across 10 companies; rebalancing would be the later action of trading to bring the drifted proportions back toward 10% eachDiversification is the ongoing maintenance action, while rebalancing is the one-time initial spread across holdingsThey describe the same action performed at two different moments, so there is no real distinctionDiversification applies only to bonds, while rebalancing applies only to equities