Every portfolio has a mix chosen on purpose: so much in stocks, so much in bonds, so much in cash, and for some clients, a thematic sleeve. The day after that mix is set, markets start changing it. Rebalancing means bringing the mix back. The harder question is when, and on what basis.
Our answer is a written range for each allocation, checked every quarter. Here is how it works, and why it often feels like the wrong thing to do.
How a portfolio drifts
Different assets move by different amounts. If stocks rise while bonds stay flat, stocks become a larger share of the portfolio without anyone deciding that. If stocks fall, the reverse happens. Left alone for a few years, a portfolio can end up carrying a very different level of risk than the one its owner chose. The statement does not announce this. The holdings look the same. Only the proportions have moved.
Drift matters because the mix is the main driver of how a portfolio behaves. A family that chose a moderate mix because it needs to draw on the money in five years did not choose a much more aggressive one. Drift makes that choice for them.
The written range
Each client’s investment policy sets a target for every allocation and a band around it. A hypothetical example: a target of 60 percent in stocks, with a range of 55 to 65 percent. Inside the band, we leave the portfolio alone. Small moves are normal, and trading on every wiggle adds cost and, in taxable accounts, can add tax. Outside the band, we act and bring the allocation back toward target.
Thematic sleeves follow the same rule. Where a client’s policy includes one, the policy sets its target and its range, and the sleeve is held to them like any other part of the portfolio. A theme that has risen does not earn a larger share by default.
The ranges are written down before anything happens. That is the point. They are set when the client is calm and has time to think about goals, spending needs and how large a decline they can live with. They are applied later, when conditions may be anything but calm.
Why quarterly
We check every portfolio against its ranges each quarter. That is often enough to catch meaningful drift and seldom enough to avoid reacting to noise. A large market move between checks can prompt an earlier review, but the test stays the same. Is the allocation outside its written range? The test is never whether the news feels alarming.
Why it feels wrong
Rebalancing asks you to do the opposite of what instinct suggests. When an allocation has risen past its range, the rule says trim it. That means selling the part of the portfolio that has been rewarding you. When an allocation has fallen below its range, the rule says add to it. That means buying the part that just caused a loss.
Both feel backward. Recent gains feel like evidence that more are coming. Recent losses feel like a warning. Headlines usually agree with the feeling of the moment. A rule is useful precisely because it does not consult the feeling.
We believe this is where a written policy earns its keep. Without one, every rebalancing decision becomes a fresh debate about where markets are headed, and nobody, including us, can answer that reliably. With one, the question is narrow and checkable.
What a rule does not do
Rebalancing is a risk discipline, not a return strategy. It does not promise a better result than leaving a portfolio alone, and there are stretches when letting a rising asset run would have ended with more money. Its purpose is to keep the portfolio close to the risk the client chose. It also has costs, including trading costs and, in taxable accounts, realized gains.
Taxes and practical tools
Selling is not the only way to rebalance. Where we can, we use tools that create less tax friction first:
- Directing new contributions to the allocation that is under target
- Taking withdrawals from the allocation that is over target
- Steering dividends and interest rather than reinvesting them automatically
- Making trades inside tax-deferred accounts where that fits the plan
Tax treatment depends on each person’s circumstances. Your accountant should be involved before trades that realize significant gains, and your attorney as well where trusts or estate plans hold the assets.
When the range should change
Ranges are not permanent. A liquidity event, retirement, a new spending need or a change in how much risk you can carry are good reasons to revisit the policy. A market move by itself is not. When targets change, we write the change into the policy first, then trade.
This article is for informational purposes only and is not investment, legal or tax advice, nor a recommendation to buy or sell any security. All investing involves risk, including loss of principal.
This material is for informational purposes only and is not a recommendation to buy or sell any security. All investing involves risk, including loss of principal.