Drift and the case for rules-based rebalancing
A 60/40 portfolio (60% stocks, 40% bonds) starts in target. In a strong bull market, stocks appreciate while bonds languish, and the portfolio naturally drifts toward 70/30 or higher. In a bear market, bonds become a larger share. This drift happens automatically, without any trading, as market values shift.
Rebalancing bands solve this by setting thresholds: rebalance when the portfolio drifts 5 percentage points from target. If a 60/40 drifts to 65/35, rebalance by selling stocks and buying bonds back to 60/40. This approach is rules-based, removing emotion. It also forces investors to 'sell high, buy low' mechanically: rebalancing during bull runs sells winners and buys losers, capturing the value-creation potential of mean reversion.
Balancing discipline with transaction costs
Tight rebalancing bands (2-3 percentage points) maintain strict diversification but trigger frequent trading, incurring costs and taxes. Wider bands (10+ percentage points) cut trading but allow significant drift from the original risk profile. Most advisors favor a middle ground (5 percentage points), rebalancing one to three times per year. The optimal band depends on portfolio size (larger portfolios can afford tighter bands due to economies of scale) and time horizon (longer horizons justify slightly looser bands).