As humans, we are wired to respond to what just happened. That instinct may have helped our ancestors survive, but in today’s investing world, it often does the opposite.
When markets rise, confidence grows. When markets fall, fear takes over. In both cases, investment decisions feel urgent, even when nothing about your financial goals has changed.
This is especially true during sharp market trends, volatile markets, or emotionally charged market environments, such as a bull or bear market. The stronger the recent experience, the harder it is to act objectively.
When we talk about portfolio rebalancing, we often treat it like a math problem. We calculate a target allocation, check the portfolio drift, and move the pieces. Rebalancing is more of a psychological test. It is the art of doing exactly what your gut tells you not to do. It is selling what has been working and buying what has been hurting.
That feels backward to many investors, even when it aligns perfectly with risk management and long-term portfolio construction.
What Portfolio Rebalancing Really Does for Investors
The Core Purpose of Portfolio Rebalancing
At its core, portfolio rebalancing exists to keep risk aligned and not to chase higher returns.
A portfolio drifts naturally over time. Assets that perform well grow larger. Assets that lag shrink. Left unchecked, this portfolio drift quietly increases portfolio risk because it is no longer allocated to the appropriate percentages you wanted to start with.
Rebalancing restores your target allocation, keeping your asset allocation aligned with your original risk tolerance, financial planning objectives, and retirement timeline.
How Rebalancing Works
The mechanics are simple:
- Sell portions of assets that have grown beyond their intended allocation
- Add to underweighted asset class exposures
- Maintain diversification across stocks, equity, funds, mutual funds, and other certain assets
The difficulty isn’t in the execution. The hardest part is the timing and your behavior.
Should you follow a rebalancing schedule? Use thresholds? Apply smart rebalancing rules? Each rebalancing framework has strengths and tradeoffs.
The Most Common Behavioral Biases That Disrupt Rebalancing
When it comes to portfolio rebalancing, why is it so hard for many investors to do it consistently? We all tend to see only what we want to see and avoid what seems unpleasant. These biases are manifested in several ways.
1. The Trap of Recency Bias
Recency bias is the tendency to believe that what happened yesterday will happen tomorrow. When market performance is high, we assume the party will never end. When certain assets are plummeting, we assume they are headed to zero. This recency makes it emotionally painful to sell your winners. You feel like you’re “cutting your flowers to water the weeds.”
2. The Mirage of Overconfidence
After a few years of strong returns, overconfidence creeps in. You begin to believe you have a “feel” for the market cycle. You might tell yourself, “I know it’s time to rebalance, but I’ll wait another month to capture more gains.” This is the death of a disciplined investment strategy.
3. Loss Aversion
We feel the pain of a loss twice as intensely as the joy of a gain. This makes many portfolios stagnant during market downturns. Investors hesitate to buy more of an asset that is currently losing money, even if it is a core part of their long-term financial goals.
Why Bias Matters: The Real Impact on Portfolio Outcomes
Bias doesn’t usually cause catastrophic mistakes. It causes a series of small ones whose repeated occurrences can slowly compound into a much larger problem.
Simple behaviors such as:
- Delaying action
- Skipping adjustments
- Reacting late
- Rebalancing too aggressively, or not at all
Over time, these choices compound into increased volatility, misaligned portfolio allocation, and lower consistency of term performance.
Studies repeatedly show that investors who rely on intuition underperform those who follow structured processes. Not because markets are predictable. It is because behavior is not predictable and feelings are not repeatable.
Rebalancing doesn’t necessarily maximize returns. It minimizes regret, surprises, and unintended risk exposure.
Quantitative Strategies to Counteract Bias
The best way to remove the “you” from investment decisions is to automate the rebalancing process. If you must think about it, you can mess it up. Here are the most effective rebalancing approaches:
Rules-Based (Threshold) Rebalancing
Instead of a schedule, you set “drift bands.” For example, if your asset allocation to stocks is 50%, you might rebalance only if it reaches 55% or 45%. This smart rebalancing ensures you only act when portfolio risk had meaningfully changed, ignoring the daily market sentiment and “noise.”
Calendar-Based Rebalancing
This involves a set rebalancing schedule, every six months or once a year. The beauty of a schedule is its simplicity. It doesn’t care about market trends or term performance. Whether the market is up or down, you follow the plan.
The Hybrid Approach
Many institutional investors use a rebalancing framework that combines both. They check the portfolio on a set schedule but only trade if the asset class has drifted past a certain target allocation. This limits frequent rebalancing, which helps manage liquidity and transaction costs.
Behavioral Coaching: How Investors Can Manage Emotions More Effectively
- Learn to think about discomfort differently: Like most things in life, when we attempt to control risks, the cost we pay is incurred before the bad event occurs. We pay premiums before we even know whether our house will burn. In the markets, we experience discomfort selling winners before we even know when a price pullback will occur. Think of rebalancing as controlling the risk of a possible future event.
- Set up an accountability structure: Have an advisor or close friend serve as your accountability partner. Have some pre-determined guardrails established. Make it harder for you to react to every short-term emotion or feeling that you feel, because you know you have already agreed to other rules.
- Understand Market Cycles: Every dynamic system, like the markets, ebbs and flows with alternating forces. It’s either above the mean or below it. Shorter-term cycles are by definition short. Understand the nature of wiggles.
Building a Bias-Resistant Rebalancing Strategy
Set Clear Allocations
Your asset allocation should reflect your risk tolerance, financial goals, liquidity needs, and retirement horizon, and not what is happening in Washington or on CNBC.
Define Rules in Advance
Decide:
- When it’s time to rebalance
- What triggers action
- When exceptions apply
A boring plan is often the most effective one.
Monitor Drift, Not Headlines
Track portfolio drift, not opinions. Drift is measurable. Narratives are not.
Coordinate Taxes and Liquidity
Effective portfolio construction considers taxes, liquid assets, and cash needs. Rebalancing should support, not disrupt, your broader financial planning.
Common Rebalancing Mistakes
- Reacting emotionally to short-term market trends
- Letting behavioral biases override structure
- Ignoring transaction costs and liquidity
- Overtrading during volatile markets
- Treating rebalancing as performance chasing
Rebalancing is not about winning the year. It’s about surviving the decades.
FAQ: Avoiding Bias in Portfolio Rebalancing
1. How often should I rebalance?
You should rebalance often enough to control risk, not so often that any associated costs start to drag on your account.
2. Does rebalancing hurt performance?
Rebalancing can hurt performance in trending markets. These tend to be temporary conditions, and therefore, more often improve your risk-adjusted outcomes.
3. Should I rebalance more during volatility?
You should still rebalance during periods of volatility, as it is likely when you feel more emotional pressure. Rules matter most then.
4. Is automation better?
Automated rebalancing is probably better for execution. Judgment still matters.
5. How do advisors help?
Financial advisors can provide accountability, perspective, and guardrails when emotions spike, all important ingredients to successful portfolio rebalancing.
How We Help Investors Stay Disciplined
Are you managing your investments based on what did well recently, or are you managing them based on what’s most likely to happen next? Guided by probabilities, we provide the structure and definition for an investment plan built for real-world uncertainty. We can’t eliminate uncertainty in your current plan, but we can minimize the surprises. As with most things in life, we are most likely to abandon our long-term goals when we have short-term surprises.
Bob Porter is the President of Porter Investments. Porter Investments is a fiduciary investment management firm based in Houston, Texas, helping self-directed and hybrid investors gain professional guidance and grow their portfolios with tactical strategies. Bob's prior work at Fidelity Investments allowed him the opportunity to advise and study a diverse group of investors.
