A portfolio does not stay where you put it. Over time, different assets grow at different rates, and the original allocation drifts. What started as 60% shares and 40% bonds might become 70% shares and 30% bonds after a strong equity market.
This drift is not a problem in itself. The problem is what the drift does to risk. A portfolio that has drifted toward shares is now more volatile than intended. A portfolio that has drifted toward bonds is now more conservative than intended. Either way, the portfolio no longer matches the original plan.
Rebalancing is the process of restoring a portfolio to its target allocation. It sounds technical, but the real value is behavioural. Rebalancing imposes a discipline that most investors struggle to maintain on their own.
This article explains what drift is, why it creates risk creep, how rebalancing works, and why it is better understood as behavioural discipline than as optimisation.
This is general educational information, not personal financial advice.
What Drift Is#
Drift is the natural tendency for a portfolio's allocation to change over time as different assets produce different returns.
Consider a portfolio that starts the year with 60% in shares and 40% in bonds. If shares return 15% and bonds return 3%, the portfolio's allocation shifts. By year-end, shares might represent 63% and bonds 37%. The investor did not choose this new allocation. It happened automatically.
Over longer periods, drift can become substantial. A strong bull market in shares can push a "balanced" portfolio to become heavily equity-weighted. A prolonged period of poor share returns can push it the other direction.
Drift is not good or bad in itself. It is simply what happens when you do nothing. The question is whether the drifted allocation still matches your goals, risk tolerance, and time horizon.
What Risk Creep Is#
Risk creep is the increase in portfolio risk that results from unmanaged drift.
When shares outperform, the portfolio becomes more heavily weighted toward shares. Shares are more volatile than bonds or cash. So the portfolio as a whole becomes more volatile than it was designed to be.
This matters because the original allocation was presumably chosen for a reason. Perhaps the investor wanted a level of volatility they could tolerate psychologically. Perhaps the allocation matched their time horizon or income needs. Drift undermines that match.
The insidious part of risk creep is that it feels good. The portfolio drifted toward shares because shares went up. The investor sees higher returns and feels successful. They may not notice that they are now taking more risk than intended until the next downturn, when the higher equity weighting produces larger losses than expected.
Risk creep works in the other direction too, though it is less discussed. If shares underperform, the portfolio drifts toward bonds and cash. This reduces volatility but also reduces growth potential. An investor who needs growth to meet long-term goals may fall short without realising why.
How Rebalancing Works#
Rebalancing restores the portfolio to its target allocation by selling assets that have grown beyond their target weight and buying assets that have fallen below their target weight.
If the target is 60% shares and 40% bonds, and drift has pushed the portfolio to 65% shares and 35% bonds, rebalancing involves selling some shares and buying some bonds until the allocation returns to 60/40.
There are several approaches to when and how to rebalance:
Calendar-based rebalancing. Rebalance on a fixed schedule, such as quarterly or annually. This is simple and predictable but may trigger trades when they are not needed (if drift is minimal) or fail to act quickly enough during volatile periods.
Threshold-based rebalancing. Rebalance when the allocation drifts beyond a defined threshold, such as 5 percentage points. This is more responsive to actual drift but requires monitoring.
Cash flow rebalancing. Use new contributions or withdrawals to nudge the portfolio back toward target, reducing the need for explicit trades. This is tax-efficient and low-cost but may not be sufficient during periods of significant drift.
Research suggests that threshold-based approaches often perform well, balancing the need to control drift against the costs of trading.¹ The exact thresholds and methods matter less than having a consistent approach.
The Counterintuitive Nature of Rebalancing#
Rebalancing feels wrong. It requires selling what has done well and buying what has done poorly.
After a strong year for shares, the instinct is to let the winners run. Why sell something that is going up? After a weak year for shares, the instinct is to avoid buying more. Why add to something that is going down?
These instincts are natural but often harmful. They lead to performance chasing: buying high and selling low. Rebalancing does the opposite. It enforces a discipline of selling high (trimming assets that have grown) and buying low (adding to assets that have shrunk).
This does not guarantee better returns. There are periods when letting winners run would have produced higher returns than rebalancing. But rebalancing is not primarily about maximising returns. It is about controlling risk and maintaining the intended investment approach.
Rebalancing as Behavioural Discipline#
The deepest value of rebalancing is not mathematical. It is behavioural.
Without a rebalancing rule, the investor must make active decisions about when and how to adjust the portfolio. These decisions are vulnerable to emotion, recency bias, and overconfidence. After a bull market, it is hard to sell shares. After a crash, it is hard to buy them. The natural tendency is to do neither, allowing drift to accumulate.
A rebalancing rule removes the decision from the moment of stress. The rule says what to do. The investor follows the rule. There is no need to assess whether "now is a good time" to sell shares or buy bonds. The assessment has already been made, in advance, when the target allocation was set.
This is similar to other behavioural systems like automatic contributions or pre-written investment rules. The goal is to reduce the number of decisions that must be made under emotional pressure. Every decision point is an opportunity for error. Rebalancing reduces decision points by providing a predetermined response to drift.
Research on behavioural factors in investing consistently shows that emotional reactions, loss aversion, and recency bias lead to poor outcomes.² Rebalancing is a structural countermeasure. It does not eliminate the emotions, but it reduces their influence on the portfolio.
What Rebalancing Does Not Do#
Rebalancing is often misunderstood as an optimisation technique that improves returns. The evidence for this is mixed.
Rebalancing does not guarantee higher returns. In trending markets, rebalancing can reduce returns by selling assets that continue to rise. The primary benefit is risk control, not return enhancement.³
Rebalancing does not eliminate risk. The portfolio is still exposed to market risk. Rebalancing simply ensures that the level of risk stays close to what was intended.
Rebalancing has costs. Trading incurs transaction costs and potentially tax consequences. Frequent rebalancing can erode returns through these frictions. The benefits must be weighed against the costs.
Rebalancing can be exploited. Research shows that predictable rebalancing by large institutional investors can be front-run by other market participants, creating hidden costs.⁴ Individual investors are less vulnerable to this, but it is a reminder that rebalancing is not free.
Practical Considerations#
For most individual investors, a simple rebalancing approach is sufficient:
- Set a target allocation that matches your goals, time horizon, and risk tolerance.
- Choose a rebalancing method. Annual or semi-annual calendar rebalancing is simple. Threshold-based rebalancing (such as acting when any asset class drifts more than 5% from target) is more responsive.
- Use cash flows when possible. Directing new contributions toward underweight asset classes reduces the need for selling and the associated costs.
- Consider tax implications. In taxable accounts, rebalancing can trigger capital gains. Rebalancing within superannuation or other tax-advantaged accounts avoids this issue.
- Do not over-rebalance. More frequent is not necessarily better. The costs and effort of constant adjustment often outweigh the benefits.
The specific approach matters less than having an approach. The discipline of following a rule is more valuable than the rule itself.
Summary#
Drift is the natural tendency for portfolio allocations to change as different assets produce different returns. Risk creep is the increase in portfolio risk that results from unmanaged drift. Rebalancing restores the portfolio to its target allocation by selling assets that have grown beyond their target and buying assets that have fallen below. The counterintuitive nature of rebalancing (selling winners, buying losers) makes it psychologically difficult, which is precisely why a rule-based approach is valuable. Rebalancing is better understood as behavioural discipline than as optimisation. It controls risk and maintains alignment with the original investment plan. It does not guarantee higher returns, has costs, and should not be done excessively. The discipline of following a consistent approach matters more than the specific method chosen.
Sources#
- Vanguard Research. (2024). Best practices for portfolio rebalancing. https://corporate.vanguard.com/content/corporatesite/us/en/corp/articles/balancing-act-enhancing-target-date-fund-efficiency.html
- Barber, B. M., & Odean, T. (2000). Trading is hazardous to your wealth: The common stock investment performance of individual investors. The Journal of Finance, 55(2), 773-806. https://doi.org/10.1111/0022-1082.00226
- Ilmanen, A., & Maloney, T. (2015). Portfolio rebalancing: Common misconceptions. AQR White Paper.
- Koijen, R. S. J., & Yogo, M. (2019). A demand system approach to asset pricing. Journal of Political Economy, 127(4), 1475-1515. https://doi.org/10.1086/701683