How to Rebalance Your Investment Portfolio

Portfolio rebalancing is one of those investment concepts that sounds simple but involves surprisingly nuanced decisions. The basic idea is straightforward: periodically adjust your holdings back to your target allocation. But the how, when, and why of rebalancing is where the real wisdom lies.

Warren Buffett takes a contrarian view on traditional rebalancing. He has famously argued that if your best investment has grown to become a large portion of your portfolio, selling it merely because it has become "too large" is counterproductive. When Buffett's Apple position grew to represent over 40% of Berkshire's equity portfolio, he did not rebalance. He recognized that his best idea deserved its largest allocation. Mechanical rebalancing, in his view, forces you to sell your winners and buy more of your losers.

However, this approach requires enormous conviction and deep knowledge of each holding. For most investors, Buffett's concentrated approach is too risky. Charlie Munger acknowledges that concentration is only appropriate when you truly understand what you own. If you cannot write a detailed essay about why each of your holdings is undervalued, you probably should not have a concentrated portfolio.

Howard Marks provides the most balanced perspective on rebalancing. He argues that the real purpose of rebalancing is risk management, not return optimization. When your stock allocation drifts significantly above your target, your portfolio becomes riskier than you intended. Rebalancing is the discipline of maintaining the risk level you consciously chose. Markets have a way of punishing investors who inadvertently take more risk than they can handle.

The frequency question is critical. Academic research consistently shows that rebalancing too frequently (monthly or quarterly) increases transaction costs and taxes without meaningful risk reduction. Annual rebalancing captures most of the benefits with minimal costs. A threshold-based approach -- rebalancing only when any asset class drifts more than 5-10% from its target -- is even more efficient because it avoids unnecessary trades during calm markets.

Benjamin Graham advocated a simple 50/50 stock-bond split with rebalancing whenever the ratio drifted significantly. This mechanical approach forced investors to buy stocks after they fell (when bonds had become overweight) and sell stocks after they rose (when stocks had become overweight). This systematic contrarianism is one of the most powerful aspects of rebalancing -- it automatically implements a buy-low, sell-high discipline.

Your Action Plan

The most important insight about rebalancing is that it is a risk management tool, not a return-enhancing strategy. It will sometimes reduce your returns by forcing you to trim your best performers. But it will also protect you from catastrophic losses when a concentrated position inevitably reverses.