Why is portfolio rebalancing necessary? How is it done?

GrahamThe Intelligent InvestorInvestment StrategyAsset AllocationRisk Management
Views: 0Created At: 8/15/2025Updated At: 10/4/2025
あすか 春香
あすか 春香
Emerging Markets Analyst

Okay, no problem. Let's talk about this topic in plain language.

Discussing Portfolio Rebalancing: Why Do It and How?

Friend, hello! Seeing you ask about "portfolio rebalancing" is a great question. It shows you're not just a beginner hoping to "buy and pray" anymore, but starting to think about managing your investments. This might sound sophisticated, but the concept and the steps are actually quite simple. Let's break it down, piece by bite-sized piece.

Why Rebalance? It's Like Steering a Ship

Think of your investment portfolio as a ship carrying two types of cargo: Equities (Stocks) and Fixed Income (Bonds).

  • Equities (Stocks): This cargo is valuable but quite lively. When the seas get rough (market volatility), it rocks the most.
  • Fixed Income (Bonds): This is much steadier, like ballast on the ship. Even in heavy seas, it doesn't rock as much.

When you set sail, you carefully calculated: 50% stocks and 50% bonds onboard. This mix allows the ship to move reasonably fast (stocks provide growth) while staying steady enough (bonds control risk). This is your "Target Allocation".

After a year of sailing, you find the markets were calm. The stock cargo surged 50%, while the steady ballast (bonds) only gained 5%. Now the ship looks like this:

  • Stocks make up over 60% of the total assets.
  • Bonds make up less than 40%.

The ship's center of gravity is off! The volatile cargo's share is too high; the bow is raised. While it might seem faster now, if a big storm hits, this ship will rock far more than you might expect, even risking capsizing.

So, rebalancing has two core purposes:

  1. Risk Control (Steadying the Ship): When stocks rise significantly, your entire portfolio's risk quietly increases. Rebalancing "unloads" the excess risk, returning you to your initially set, comfortable, sleep-well-at-night risk level.
  2. Disciplined "Selling High, Buying Low" (Smart Trading): The act of rebalancing automatically and mechanically forces you to do the hardest thing in investing: "sell what's gone up a lot, buy what's gone up little or fallen." You don't need to guess market tops and bottoms; the rule does it for you. Selling some of your high-flying stocks locks in profits. Buying lackluster or fallen bonds/stocks means adding during dips. This is the very discipline championed by Graham in The Intelligent Investor.

How Exactly Do You Do It? Simple Three-Step Approach

It's simpler to execute than you might think. The key is planning ahead.

Step 1: Determine Your Target Allocation Ratio

This is your "nautical chart." The classic example is Graham's recommended 50% stocks / 50% bonds.

Of course, this ratio isn't set in stone. If you're young and can tolerate risk, you might set 70% stocks / 30% bonds. If you're nearing retirement and prioritize stability, perhaps 30% stocks / 70% bonds.

Crucially: Once set, stick to it!

Step 2: Set the "Trigger" (When to Act?)

When do you need to step in and steady the ship? There are usually two types of "triggers":

  1. Time-Based Trigger: The most hands-off method. For example, decide to check your portfolio every six months or every year on a fixed date (like your birthday or New Year's Day). If the allocations have drifted, take action to rebalance back to target.
  2. Threshold-Based Trigger: More flexible. You set a "deviation tolerance," like 5%. Using the 50/50 example, you rebalance when stocks hit 55% (50% + 5%) or drop to 45% (50% - 5%).

Beginner Suggestion: Start with the "Time-Based Trigger," like an annual rebalance. Simple, brainless, and effective.

Step 3: Execute the Trades (Sell What? Buy What?)

Once the trigger is hit, act. The operation is very straightforward:

  • Sell assets that have surged and are now exceeding their target allocation.
  • Use the proceeds to buy assets that are below their target allocation.
  • Continue until the proportions are back in line with your targets.

An Example - Crystal Clear

Assume you initially invested CNY 100,000 with a target of 50% stocks / 50% bonds.

  • Initial State:
    • CNY 50,000 in a stock fund
    • CNY 50,000 in a bond fund

After one year, the stock market booms. Your stock fund grows to CNY 70,000. The bond market is flat; your bond fund grows to CNY 52,000 (say, slight interest).

  • Current State:
    • Total Assets = 70,000 + 52,000 = CNY 122,000
    • Stock Allocation = 70,000 / 122,000 ≈ 57.4%
    • Bond Allocation = 52,000 / 122,000 ≈ 42.6%

See? Stocks have "drifted" from 50% to 57.4%. Your ship is "listing," and risk has increased. Time to "rebalance"!

  • Rebalancing Action:
    1. Your target is to return both stocks and bonds to 50%.
    2. The new total assets are CNY 122,000, so the target for each asset class is CNY 61,000 (122,000 * 50%).
    3. You need to sell CNY 9,000 worth of stocks (70,000 - 61,000).
    4. Use the CNY 9,000 from the sale to buy more of the bond fund.
  • Balanced State:
    • Stock Assets: CNY 61,000 (50% of 122,000)
    • Bond Assets: CNY 61,000 (Original 52,000 + New purchase 9,000)

Done! Your ship is stable and optimized again. Unconsciously, you've executed a beautiful "sell high (stocks), buy lowish/low (bonds)" trade.

To Summarize

  • Why Do It? To manage risk so you can sleep at night; and it's a disciplined tool that automates "selling high and buying low," helping overcome greed and fear.
  • How? Set your target allocation (e.g., 50/50), set your action trigger (e.g., annually), then sell the overweight asset and buy the underweight asset.

Hope this explanation helps! It's really a simple yet powerful tool, especially valuable during times of high market volatility.

Created At: 08-15 15:57:34Updated At: 09-30 07:49:27