Compare the two main rebalancing rules and pick one for your own portfolio.
Take a card, or open a note on your phone, and write down the rule you use now for rebalancing, in one or two lines. A rebalancing rule has to be specific enough to fit on a card. "When it feels right" is not a rule, and in practice it usually means never rebalancing. Lesson 6.1, "Why your allocation drifts", showed what happens to a portfolio that has no rule.
Grace asked three friends how often they rebalance. The first rebalances every January without fail. The second rebalances whenever anything is more than five points off target. The third said she rebalances "when it feels right", which turned out to mean never. Grace saw that the first two each had a rule that could be written on a card and the third did not. Those two rules are the two main kinds, calendar and threshold, and many people end up using a hybrid of the two.
Calendar rebalancing resets your portfolio to its target on fixed dates, whatever has happened in between. Once a year is the most common choice. Some people rebalance every six months or every quarter.
On the date, add up all your holdings, compare each asset's percentage with its target, and trade back to the target, however small the gap. If your target is 65% shares and shares are at 68% (example figures), you move three points from shares to bonds. If shares are at 65.4%, you still move 0.4 points.
The main strength is that it is simple. You can put the date in your calendar now and not think about rebalancing between dates. In calm markets it is easy to follow, because there is no decision to make, only a task.
It has two weaknesses. First, it ignores what happens between dates. If shares fall 35% in March and your date is in January, the portfolio runs far below its share target for most of a year before the rule notices. Second, it can force trades when the drift is tiny, like the 0.4 point move, and those trades cost commission and spread for very little benefit.
Threshold rebalancing acts only when an asset drifts outside a band around its target, and leaves everything alone inside it. A common band is five percentage points either side of target. With a 65% share target, you rebalance if shares rise above 70% or fall below 60%.
To run it, set a target and a band, then check the numbers at least monthly, and more often when markets move fast. If an asset is outside its band, rebalance to target. Otherwise do nothing.
A threshold rule responds to big moves when they happen. After a sharp fall, shares may cross the lower edge of the band within weeks, and the rule tells you to buy while prices are down. Small drifts never trigger a trade, so you only pay trading costs when the drift is worth correcting.
The weakness is the checking. Someone has to look often enough to notice a crossed band, and that is easy to plan but hard to keep up for years. The rule also tends to trigger after a big rise or a big fall, when people are least inclined to follow it.
Band width is a judgement call. A narrow band of two points triggers often and costs more in trading. A wide band of ten points lets risk drift a long way. Five points is a common middle ground but not a magic number, so choose a width you can defend.
The hybrid checks on a fixed date, for example once a year or every six months. You add up your holdings and see whether any asset is outside its band. If one is, you rebalance to target. If none is, you do nothing until the next date.
Farhan chose the hybrid. He wrote his rule as: on the first Saturday of January and July, total my holdings; if shares are above 70% or below 60%, rebalance back to 65/35; otherwise do nothing.
The hybrid keeps the simplicity of a date, so you know when to look, and the restraint of a band, so you don't trade over trivial drift. It gives up the instant response of a pure threshold rule, so a crash in February might not be acted on until July. Many investors accept that trade-off, because a rule checked twice a year actually gets followed, while a rule that needs weekly checking is often abandoned.
Some investors also check outside the calendar after a very large market move, such as shares falling by a third. If you add an exception like this, write the trigger down in advance so it doesn't turn into a reason to check every day.
The best rule is the one you will follow in both a crash and a boom, so be honest about how often you actually look at your investments: daily, monthly or twice a year. If you check the app daily anyway, a threshold rule makes good use of that habit. If you'd rather look twice a year and forget about it otherwise, choose a calendar rule or the hybrid. If you invest every month, new money can do much of the rebalancing for you, as lesson 6.3 shows, so your rule's dates matter a little less.
Grace chose a pure calendar rule, once a year in her birthday month, because she knows she will not check monthly.
Go back to your card and write your rule properly. When you write yours, include the dates or the bands, and one honest sentence on why it fits how you actually behave.
Pick a calendar, threshold or hybrid rule. Write down the dates or bands, then explain in two sentences why you chose it.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).