Portfolio rebalancing is an activity that occurs when your investments are already running at full speed. It happens after we do all the upfront heavy lifting to determine your risk preferences and goals. Effectively, it is the result of actively monitoring your investments and making sure the portfolio stays in the same condition it was in when you started.

Remember all that talk about asset allocation? That is the output of the onboarding process, where your ideal mix of stocks and bonds are dependent on your specific needs. For example, let’s say when you sign up with Investable, we determine that your optimal asset mix is 60% stocks and 40% bonds. In our world, we call that a “balanced” portfolio mix. In the words of Goldilocks and the Three Bears, “Not too hot, not too cold. Just right.” With a “60/40” portfolio, most investors are looking for a balanced combination of upside (and risk) from stocks and the relative safety of bonds.

However, over time, that 60/40 mix can get out of whack. Over the past 15 years, stocks average an annual return of almost 14%, while bonds have averaged less than 3%. Just like running a race around a track, over time, the faster racer will inevitably lap the slower runner, making the score quite uneven. With a balanced portfolio, the same can happen. If stocks continuously have stronger returns than bonds, at some point, the mix gets uneven. In other words, it’s no longer 60/40:

Similarly, in the unfortunate event that stocks decline more than bonds, the opposite effect will occur, with bonds becoming a disproportionate share of the portfolio:

(Note: in the real world, both stocks and bonds go up some years and down in others. These are just simple examples).

In the first case, the strong performance of stocks has thrown its mix to over 70% of the portfolio, which could be considered “too risky” for a person with a balanced portfolio. In the second example, the downturn in stocks has resulted in a portfolio that holds more bonds than stocks! This may be considered “too conservative” for that balanced individual. In either situation, the mix has been turned upside down, which is not what the investor signed up for.

Enter the art of rebalancing. We say art because there are many ways to approach rebalancing. Some investment professionals do it regularly (i.e., quarterly or twice a year), others do it when the mix breaches the maximum thresholds in what they deem acceptable. Regardless, it is the activity of “resetting” your portfolio to its initial state. If your original 60/40 portfolio has become a 70/30 (Example 1), we’ll sell some stocks and buy more bonds to bring it back to par. Conversely, if you’re staring at a 50/50 portfolio (Example 2), we’ll sell some bonds to buy more stock. With rebalancing trades, the objective is to bring your portfolio back to equilibrium. In other words, the markets take stocks and bonds on wild adventures each and every day. It’s our job as investors to know when to bring them back to the safety of home.

At Investable, we’ve automated the rebalancing process for your account by placing upper and lower bounds on your individual holdings. This ensures no ETF (therefore no asset class) gets too big or too small. We’ve also made these bounds wide enough where we feel the investments can roam relatively freely without incurring too many trades. That’s the fine balance of rebalancing, minimizing excessive transactions but also keeping the intended asset allocation intact.

So to review, rebalancing is the portfolio management practice of monitoring your investments while they’re in flight. The purpose is to ensure that the portfolio is staying on the track we set it upon when you started the journey. If you want a portfolio with 60% stocks and 40% bonds, our long term objective is to stay on that path. While there’s no “perfect” rebalancing method, most acceptable methods prioritize the well-being of the portfolio in the best interests of the client and their intended preferences. Not too hot. Not too cold. Juuuuust right.