Rebalancing Strategies in Depth
Calendar rules and band rules compared over a century of data, what rebalancing really does to return and risk in different markets, when a rebalancing bonus exists, and how to design a rule that limits trading and tax.
The short version
Rebalancing brings a portfolio back to its chosen mix after markets have pulled it away. Tested on 98 years of US shares and bonds, the choice of rule made almost no difference: rebalancing every year, every three years, or only when the mix drifted by 5 or 10 points all gave nearly the same return and risk. What mattered was rebalancing at all. A 60/40 portfolio left alone ended up almost entirely in shares, with a higher return and far more risk. Rebalancing is risk control. It adds return only in particular conditions, and it costs return when one asset keeps outrunning the other. A good rule is one that trades rarely, uses new money where it can, and is written down before the market tests it.
By the end of this lesson, you'll be able to
- Compare calendar and band rebalancing rules by their results and by how often they trade
- Explain when rebalancing adds to return, when it subtracts, and why its main effect is on risk
- Design a rebalancing rule that takes costs, taxes, and contributions into account
Why this matters
Portfolio Drift and Rebalancing showed what drift does and the basic ways to correct it. That leaves the questions investors argue about. How often? By the calendar or by how far the mix has moved? Does rebalancing raise returns, as is sometimes claimed, or lower them? This lesson answers with data, and the answers are simpler than the arguments suggest.
Five rules, one century
Take a portfolio that starts with 60% in the S&P 500 and 40% in 10-year Treasury bonds at the beginning of 1928, and apply five different rules through 2025. The mix is checked once a year, at the year end.
| Rule | Return a year | Standard deviation | Worst year | Times rebalanced | In shares at the end |
|---|---|---|---|---|---|
| Every year | 8.3% | 12.1% | −27.3% | 98 | 60% |
| Every three years | 8.4% | 12.1% | −27.3% | 32 | 68% |
| When shares drift 5 points from 60% | 8.4% | 12.2% | −27.3% | 35 | 62% |
| When shares drift 10 points from 60% | 8.4% | 12.3% | −26.3% | 15 | 68% |
| Never | 9.5% | 15.8% | −35.5% | 0 | 99.6% |
Returns are compound yearly rates from Aswath Damodaran's data, before trading costs, taxes, fees, and inflation.1
Read the first four rows together. Whether the portfolio was rebalanced 98 times or 15, the return was 8.3% to 8.4% and the standard deviation 12.1% to 12.3%. The differences are far smaller than the uncertainty in any of the figures. The rule that traded least did as well as the rule that traded most.
The last row is a different portfolio. Left alone, it earned about a point a year more, because shares returned more than bonds and were allowed to take over. By the end it was 99.6% in shares. Its risk was the risk of a share portfolio, and so was its worst year. An investor who chose 60/40 because a 35% loss in a year was more than they could take didn't have a 60/40 portfolio for most of that century.
What it does to return depends on the market
Over the whole period, rebalancing cost about a point of return a year and removed about a quarter of the risk. Shorter periods show why the effect on return has no fixed sign.
| Period | Shares, a year | Bonds, a year | Rebalanced yearly | Never rebalanced | In shares at the end, if never rebalanced |
|---|---|---|---|---|---|
| 2000 through 2012 | 1.6% | 6.9% | 4.6% | 4.1% | 44% |
| 2009 through 2021 | 15.8% | 2.7% | 10.8% | 12.5% | 88% |
Each portfolio starts at 60/40 at the beginning of its period.1 From 2000 through 2012, shares fell twice and recovered twice. Rebalancing bought them after each fall and sold them after each recovery, and earned half a point a year more. From 2009 through 2021, shares rose almost without a break. Rebalancing kept selling the winner, and gave up 1.7 points a year.
So rebalancing helps when markets swing back and forth, and costs when one asset trends for years. Nobody knows in advance which kind of period is coming. What rebalancing does reliably is keep the mix, and so the risk, where it was set.
The rest of this lesson is for members
Still to come in this lesson: The rebalancing bonus, and when it's real, Costs and taxes, The hard part, Designing a rule, the key takeaways, and 2 quiz questions with explanations.
Membership opens every lesson in the curriculum, the capstone projects, the interactive tools, and the members-only channels in the Hyperion Entities Discord. The first lesson of every module stays free.
Go deeper
- Risk Parity and Other Portfolio ApproachesPortfolio Theory and Risk (depth track)
- Portfolio Drift and RebalancingPart 5: Building a Portfolio
- Asset LocationPart 6: Strategy, Behavior, Accounts, and Taxes
- Arithmetic and Geometric AveragesMath and Statistics for Investors (depth track)
Notes and sources
- Aswath Damodaran, NYU Stern School of Business. Historical Returns on Stocks, Bonds and Bills, with annual data through 2025 (updated January 2026). Checked 2026-10-12. Back to text
- Internal Revenue Service. Topic no. 409, Capital gains and losses. Checked 2026-09-30.