Rebalancing

A portfolio with a target mix, such as 60% US Equity, 25% Bonds and 15% Intl Equity, drifts as its classes rise and fall at different rates. A year in which US stocks outrun the rest leaves that class holding more than 60% and the other two holding less. Rebalancing is the set of trades or contributions that puts each class back at its target share.

The arithmetic is the same whichever way it is done. A class's target share of the portfolio's current value is a dollar amount, and the difference between that and what the class holds today is what has to move. A class above target gives up the difference, and a class below target takes it in.

With new money, nothing is sold. The contribution goes to the classes below target, and the portfolio's value grows until the over-weighted class's unchanged dollar amount is once again its target share of the whole.

A $200,000 portfolio has a target of 60% US Equity, 25% Bonds and 15% Intl Equity. After a year it holds $132,000 of US Equity, $44,000 of Bonds and $24,000 of Intl Equity: 66%, 22% and 12%.

At $200,000, the targets in dollars are $120,000, $50,000 and $30,000. US Equity is $12,000 above its target and the other two are $6,000 below theirs each. Moving $12,000 out of US Equity, $6,000 into each of the others, puts the mix back at 60/25/15.

The same portfolio reaches 60/25/15 with no sale if $20,000 of new money goes to the classes below target: $11,000 to Bonds and $9,000 to Intl Equity. The portfolio is then $220,000, and the untouched $132,000 of US Equity is 60% of it.

US Equity target, 60% × $200,000

$120,000

US Equity held

$132,000

US Equity above target

$12,000

Bonds below target, $50,000 − $44,000

$6,000

Intl Equity below target, $30,000 − $24,000

$6,000

Moved to restore 60/25/15

$12,000

A target mix is a decision about how much of the portfolio sits in each class. Drift undoes it a little at a time. In the example, a portfolio set to hold 60% in US stocks holds 66% until $12,000 moves.

Because the dollar amounts fall out of the target and the current value, the size of a rebalance is set before the method is: $12,000 in the example, however it is moved. The two methods differ in what else they do. A sale of a class above target in a taxable account realizes the gain or loss on the shares sold; a rebalance made with new money sells nothing and realizes none.

Taiga Finance shows the gap and no rebalancing step. On Investments, a portfolio with a target opens a strip that lists each asset class as its current share, an arrow and its target share, under the caption “Current → Target”. The strip reads “On target” while every class sits inside the threshold set in the target dialog, in percentage points, and “Off target” once one class passes it.

It lists no trades, amounts or funds to buy; the dollar amount that would move a class back to its target is not on the page.