Portfolio construction

Rebalancing: schedules, drift bands and trading costs

Why a portfolio drifts away from its targets and the ways to bring it back: by the calendar, by a drift band, or by hand.

2 min read · Try it in the portfolio optimiser ↗

The idea in plain words

Weights move with prices: a ticker that rises becomes a bigger part of the portfolio and its risk grows. Rebalancing sells some of what rose and buys what fell, back to the targets. It keeps the risk you chose and, in markets that swing back and forth, adds a small "rebalancing bonus".

How it is calculated

Each ticker's current weight is its value ÷ the portfolio's value; drift is current weight − target. A rebalance trades each ticker by (target − current weight) × portfolio value. Our portfolios do it on a schedule (weekly, monthly, quarterly), when any weight drifts more than your band (e.g. 5 points), or when you press Rebalance now; differences under the smallest trade you set are left alone.

wᵢ(now) = valueᵢ ÷ Σ value
driftᵢ = wᵢ(now) − wᵢ(target)
tradeᵢ = −driftᵢ × portfolio value

How to use it

Monthly or quarterly plus a 5-point drift band suits most portfolios: few trades, risk kept in check.
Set the smallest trade to about 1% so that tiny differences do not generate costs.
Rebalance to a new model (Compare models… on the portfolio) when you change your mind about the mix, not after every study.

Drawing conclusions

Frequent small drifts mean volatile tickers; a wider band saves trades.
Orders for a closed market wait and are carried out when it opens.

Example

Running example (used in every portfolio guide): US500, GER40, gold (XAUUSD) and EURUSD, two years of daily data. Expected returns 8%, 7%, 7% and 1% a year; volatilities 18%, 20%, 15% and 7%. US500 and GER40 move together (correlation about 0.7); gold hardly moves with the indices (about 0.04). A $5,000 portfolio at 50% EURUSD and 30% gold (the rest in cash) with a 5-point band. Gold rises 30%: the portfolio is worth $5,450 and gold's weight is now 35.8%, past the band. The rebalance sells about $315 of gold (back to 30%) and buys about $225 of EURUSD (back to 50%).

The example's inputs are illustrative; the weights and figures are what our optimiser returns for them.

Watch out for

Every trade pays the spread; rebalancing too often turns a small benefit into a cost.
In a long one-way trend, rebalancing sells the winner early; that is the price of keeping the risk constant.

A little history

André Perold and William Sharpe compared constant-mix rebalancing with buy-and-hold and portfolio insurance in "Dynamic Strategies for Asset Allocation" (Financial Analysts Journal, 1988): rebalancing wins in markets that swing back and forth and loses in strong one-way trends.

Educational content only. No portfolio model knows the future: every one of them works on estimates from the past, and nothing here is investment advice.