When & How to Rebalance?

There are 3 basic strategies one can adopt to decide when to rebalance a portfolio:

  1. Time-only rebalancing strategy : In this case, portfolio is rebalanced at regular intervals like quarterly, semi-annually or yearly. Regardless of how much or how little weights of constituents within a portfolio drift from their target, rebalancing will be done only at a pre determined time. Determining the frequency of rebalancing depends mainly on how much risk an investor wants to take, an investor who wants to avoid risk will rebalance more and vice versa.
  2. Threshold-only strategy : This strategy involves rebalancing the weights of the portfolio only if they drift away from the weights set on day 0 by a predetermined margin, like 2%, 5% or 10%. The frequency of rebalancing is irrelevant and might happen as regularly as once every month or once every 3 years.
  3. Time and threshold : Portfolio will be rebalanced on a scheduled basis (monthly, quarterly or annually) only if its weight has drifted away from the weight set on day 0 by a predetermined minimum rebalancing margin, such as 2%, 5%, or 10%. If at the time of rebalancing, the portfolio’s weights have deviated by less than the predetermined margin the portfolio will not be rebalanced. If the portfolio’s weights drifts by more than the minimum margin at an intermediate time period, the portfolio will then not be rebalanced.

Now let’s understand the process of how a portfolio should be rebalanced.

STEP 1: Recording target portfolio mix and target rebalancing schedule

When purchasing the scrip’s, record the total cost of each security and the total cost of the portfolio. Number of shares bought will be contingent on the desired portfolio weight of each security. First decide on the rebalancing strategy to be adopted, time and threshold strategy is comprehensive and is the recommended strategy. For illustration purpose let’s assume a margin of 10%, i.e if the weights change by more than 10% portfolio will be rebalanced. The period of rebalance will be quarterly. So if the weights change by more than 10% during a quarter, the weights will be rebalanced at the end of the quarter.

Here’s a sample equi-weighted portfolio:

StockDay 0
Number of sharesMarket PriceNet WorthWeight of Stocks

STEP 2: Compare the actual weight with the target weight after 3 months

StockDay 0End of Q1Target Weights 
Number of sharesMarket PriceNet WorthWeight of StocksMarket PriceNet WorthWeight of StocksLow LimitHigh LimitRebalancing Required?

At the end of 1st quarter no rebalancing action is required, though weights of shares have moved, they are within the margin.

Lets analyze the same portfolio 3 months later:

StockDay 0End of Q2Target Weights
Number of sharesMarket PriceNet WorthWeight of StocksMarket PriceNet WorthWeight of StocksLow LimitHigh Limit

We can see that SBI and Allahabad Bank have breached the 10% margin and hence the portfolio will have to be rebalanced.

STEP 3: Buy and/or sell shares to rebalance

The number of shares to be bought or sold is as below:

StockBought on Day 0Position after rebalancingBuy (/Sell)

Rebalancing allows us to reap the full benefit of diversification and hence should be carried out regularly.