The Rebalancing Playbook: When, Why and How to Adjust Your Portfolio

Portfolio rebalancing isn’t a major focus for most investors. Yet, it’s one of the few disciplines that materially shapes long-term investment outcomes. It determines how risk compounds, how your behaviour interferes with your performance, and ultimately whether your portfolio shape is intentional or accidental.

This is particularly true for ETF investors, many of whom build wonderfully simple portfolios using only a couple of diversified ETFs. Simplicity, however, doesn’t remove the need for portfolio maintenance. It just makes the consequences of neglect more visible.

The Hidden Drift Behind Most Portfolios

Consider one of the most common starting points for Australian investors: a two-ETF portfolio split between domestic equities and global equities.

A typical allocation might be:

• Australian equities via a broad market ETF such as Vanguard Australian Shares Index ETF (VAS);

• Global equities via an international developed markets ETF such as Vanguard MSCI Index International Shares ETF (VGS).

Assume a 50/50 allocation at the start of 2025.

By the end of that year, performance alone would have shifted that balance.

VAS delivered a total return of 10.07%, while VGS returned 13.34%.

So, without any investor action, this portfolio would now be slightly overweight global equities.

Of course, one year’s drift isn’t where the real problem lies. It’s when portfolios are neglected for long periods of time, during which the performance differentials compound into significant weighting changes.

That’s when a portfolio that began as balanced exposure between domestic income and global growth can inadvertently transform into a more internationally concentrated, higher-growth, higher-volatility portfolio.

During this unintentional process, an investor is effectively taking on more currency exposure and less franking credit income than they’d intended without making a single decision.

This is why rebalancing is an important part of portfolio management. Markets move. Your allocations move with them.

The Benefits of Rebalancing

At its core, rebalancing is the act of restoring a portfolio to its intended shape.

But its deeper function is behavioural.

A rebalanced portfolio systematically sells what has outperformed and buys what has lagged.

This process prioritises discipline in an area where human emotions often guide investors to do the opposite. In particular, investors are naturally inclined to hold onto their recent winners and reluctant to add to their underperformers.

The mechanical discipline of forcing investors to act against their emotions is precisely why rebalancing creates value at a portfolio level. This is known as the diversification return; the incremental benefit that arises when volatile assets are periodically reset to their target weightings. It’s about harvesting volatility to an investor’s benefit.

This achieves three things:

- Controls risk.

Equity-heavy portfolios tend to become even more equity-heavy toward the end of bull markets. Without intervention, a 50% equity allocation can easily drift towards 70% or higher, which materially changes a portfolio’s risk profile.

Rebalancing allows investors to actively reduce their risk, often at times when equity markets are toppy or overvalued.

-Stabilises outcomes.

By trimming winners and reinforcing laggards, rebalancing avoids a portfolio becoming overly dependent on a single asset class or geography. This is core to improving risk-adjusted returns.

-Improves investor behaviour.

The research consistently shows that investors who trade reactively tend to underperform those who follow a disciplined, rules-based approach. Rebalancing allows investors to be on the right side of that reality.

An Example of the Benefits

T.Rowe Price research compares what happens to a $100k portfolio which is rebalanced over ten years with a portfolio that’s left to its own devices.

As shown below, this portfolio’s rebalancing decisions generally occurred at prudent times; i.e. they bought more equities when markets were low and sold more when markets were high or toppy (as you’d expect).

The result is that the rebalanced portfolio outperformed by 10.7% over the ten-years.

That’s an extra 1% p.a. performance for some basic annual portfolio maintenance which is evidence of the value of rebalancing.

When to Rebalance: Timing Less Important than Discipline

When it comes to rebalancing, investors often overthink the timing.

In reality, the regularity of rebalancing matters far less than the consistency.

A widely cited approach is to review portfolios annually, or otherwise when one or more allocations have drifted by 5%+ from their target weights.

For example, with this approach, when a portfolio’s equity weighting has increased from 60% to 68%, that would trigger a portfolio rebalancing back to target weightings.

This strikes a balance between risk control and transaction costs.

Context is also relevant to this strategy.

For example, it’s important to respond to life changes such as retirement, receiving an inheritance, or major income shifts. All of these changes should probably trigger a review of your investment plan and where your portfolio is versus the plan.

Tax considerations are also worthy of consideration. Rebalancing inside tax-advantaged structures or using new contributions rather than selling can improve investment outcomes.

What matters most, though, is that rebalancing happens at all. Doing it regularly is the best way to use it to your advantage.

How to Rebalance Without Undermining Returns

This all sounds simple, but how do you rebalance your portfolio?

Like all other aspects of investing, execution matters.

Done poorly, rebalancing can generate unnecessary costs and tax liabilities.

Done well, it’s almost invisible.

The most efficient approach is often the simplest:

• New capital flows can be directed into underweight assets.
• Dividends can be reinvested selectively into underweight assets.
• Only when imbalances become material (over 5%) does selling become necessary.

For example, if global equities have outperformed, new contributions can be allocated to Australian equities or bonds rather than trimming positions immediately.

This reduces transaction costs and defers capital gains.

Another approach is to use diversified funds that rebalance internally. Through multi-asset ETFs and diversified managed funds, you can partially outsource the process.

Having said that, many experienced investors prefer maintaining control, particularly when tailoring their exposure to their personal investment plans.

A Behavioural Edge

Markets reward patience but punish inconsistency. This is why investors who abandon their strategy during periods of volatility often lock in losses or miss the subsequent recoveries.

Rebalancing provides a framework that removes the emotion from decision-making. It turns volatility from a source of anxiety into an opportunity for disciplined adjustment. In a market environment where the top and bottom performing asset classes are rarely similar one year to the next, this discipline adds significant value over the long-term.

So, review and rebalance your portfolio regularly. Accept that drift is inevitable. Act when it becomes meaningful. Above all, recognise that rebalancing is a commitment to your strategy.

Funds Mentioned

Disclaimer: This article is prepared by Simon Turner. It is for educational purposes only. While all reasonable care has been taken by the author in the preparation of this information, the author and InvestmentMarkets (Aust) Pty. Ltd. as publisher take no responsibility for any actions taken based on information contained herein or for any errors or omissions within it. Interested parties should seek independent professional advice prior to acting on any information presented. Please note past performance is not a reliable indicator of future performance.