Rebalancing Your ETF Portfolio: When and How

Rebalancing is the process of realigning your portfolio back to your target asset allocation. As markets move, your portfolio's allocation drifts from your original targets. Rebalancing brings it back in line, maintaining your desired risk-return profile. This guide explains when and how to rebalance your ETF portfolio.

What is Rebalancing?

Rebalancing involves buying and selling assets to restore your target allocation. For example:

Target Allocation:

• 60% Australian ETFs (VAS)
• 40% International ETFs (VGS)

After Market Movements:

• 70% Australian ETFs (overweight)
• 30% International ETFs (underweight)

Rebalancing Action:

• Sell some Australian ETFs
• Buy more International ETFs
• Restore 60/40 allocation

Why Rebalance?

1. Maintain Risk Profile

Your target allocation reflects your risk tolerance. As allocations drift, your risk profile changes. Rebalancing keeps risk in check.

2. Enforce Discipline

Rebalancing forces you to "sell high, buy low" - trimming winners and adding to underperformers. This counterintuitive approach can improve returns.

3. Lock in Gains

Rebalancing allows you to realize gains from outperforming assets and reinvest in underperforming areas.

4. Stay on Track

Keeps your portfolio aligned with your investment goals and strategy.

When to Rebalance

Time-Based Rebalancing

Annual Rebalancing:

• Review and rebalance once per year
• Simple and systematic
• Reduces emotional decision-making
• Suitable for most investors

Semi-Annual Rebalancing:

• Review every 6 months
• More frequent adjustments
• May catch larger drifts earlier
• Slightly more active approach

Quarterly Rebalancing:

• Review every 3 months
• Very active management
• Usually unnecessary for most investors
• May increase costs and complexity

Threshold-Based Rebalancing

Rebalance when allocations drift by a certain percentage:

5% Threshold:

• Rebalance when any asset class drifts 5% from target
• Example: Target 50%, current 55% or 45% = rebalance
• Most common threshold
• Balances frequency with costs

10% Threshold:

• Rebalance when allocations drift 10% from target
• Less frequent rebalancing
• Lower transaction costs
• May allow larger drifts

Absolute Threshold:

• Rebalance when absolute difference exceeds set amount
• Example: Rebalance if difference > 5 percentage points
• Works well for larger portfolios

Hybrid Approach

Combine time and threshold:

• Review annually
• Rebalance if allocations drift 5%+ from target
• Otherwise, wait until next review

How to Rebalance

Method 1: Sell Winners, Buy Losers

Process:

1. Identify overweighted assets (above target)
2. Sell excess to bring back to target
3. Use proceeds to buy underweighted assets
4. Restore target allocation

Example:

• Target: 60% VAS, 40% VGS
• Current: 70% VAS, 30% VGS
• Action: Sell 10% of VAS, buy 10% more VGS

Pros:

• Directly addresses allocation drift
• Realizes gains from winners
• Reinvests in underperformers

Cons:

• Triggers capital gains tax
• Requires selling (emotional barrier)
• Brokerage costs

Method 2: Use New Money

Process:

1. Direct new investments to underweighted assets
2. Gradually restore allocation
3. Avoid selling existing holdings

Example:

• Target: 60% VAS, 40% VGS
• Current: 70% VAS, 30% VGS
• Action: Direct all new money to VGS until 40% reached

Pros:

• No capital gains tax
• No selling required
• Emotionally easier
• Lower costs

Cons:

• Takes longer to rebalance
• Requires regular new investments
• May not fully rebalance if no new money

Method 3: Dividend Reinvestment

Process:

1. Redirect dividend reinvestment plans
2. Reinvest in underweighted assets
3. Gradually restore allocation

Pros:

• Uses existing cash flow
• No additional investment needed
• Automatic process

Cons:

• Slow rebalancing
• May not fully address large drifts
• Less control

Rebalancing Strategies

Calendar-Based Strategy

Approach:

• Set specific dates (e.g., January 1st, July 1st)
• Review portfolio on those dates
• Rebalance if needed

Best for:

• Systematic investors
• Those who prefer routine
• Avoiding emotional decisions

Threshold-Based Strategy

Approach:

• Monitor allocations regularly
• Rebalance when threshold exceeded
• Otherwise, leave portfolio alone

Best for:

• Active investors
• Those comfortable monitoring
• Cost-conscious investors

Hybrid Strategy

Approach:

• Annual review
• Rebalance if drift exceeds threshold
• Use new money when possible

Best for:

• Most investors
• Balances simplicity and effectiveness
• Cost and tax efficient

Tax Considerations

Capital Gains Tax

Rebalancing by selling triggers CGT:

• Short-term (<12 months): Full CGT applies
• Long-term (12+ months): 50% CGT discount
• Losses: Can offset gains

Tax-Efficient Rebalancing

Strategies:

1. Use new money: Avoids CGT entirely
2. Wait for 12 months: Benefit from CGT discount
3. Harvest losses: Offset gains with losses
4. Superannuation: Lower tax environment
5. Rebalance in down markets: Realize losses for tax benefits

Common Rebalancing Mistakes

1. Rebalancing Too Frequently

• Increases costs (brokerage fees)
• Triggers unnecessary CGT
• May reduce returns through overtrading
• Creates emotional stress

Solution: Stick to your schedule (annual or threshold-based)

2. Not Rebalancing at All

• Portfolio drifts from targets
• Risk profile changes
• Miss rebalancing benefits
• Lose discipline

Solution: Set a rebalancing schedule and stick to it

3. Emotional Rebalancing

• Rebalancing based on fear or greed
• Chasing performance
• Market timing attempts
• Deviating from strategy

Solution: Use systematic, rules-based approach

4. Ignoring Costs

• Frequent rebalancing increases costs
• Brokerage fees add up
• Tax implications reduce returns
• Not considering total cost

Solution: Factor in all costs when deciding to rebalance

Rebalancing Example

Starting Portfolio (January 2024)

• $60,000 in VAS (60% target)
• $40,000 in VGS (40% target)
• Total: $100,000

After Market Movements (December 2024)

• VAS: $75,000 (now 68% - overweight)
• VGS: $35,000 (now 32% - underweight)
• Total: $110,000

Rebalancing Action

Option 1: Sell and Buy

• Sell $8,800 of VAS (brings to 60%)
• Buy $8,800 of VGS (brings to 40%)
• New allocation: 60/40

Option 2: Use New Money

• Add $13,200 to VGS
• New total: $123,200
• New allocation: 61% VAS, 39% VGS (close enough)

Rebalancing Tools

Manual Calculation

Calculate target amounts:

• Target % × Total Portfolio Value = Target Amount
• Current Amount - Target Amount = Rebalancing Needed

Spreadsheet Tracking

Create a simple spreadsheet:

• Track current allocations
• Calculate target amounts
• Identify rebalancing needs
• Monitor over time

Online Calculators

Various tools available:

• Portfolio allocation calculators
• Rebalancing calculators
• Asset allocation tools

Special Considerations

All-in-One ETFs

ETFs like VDHG handle rebalancing internally:

• No need to rebalance yourself
• Provider manages allocation
• Simpler but less control
• Slightly higher fees

Life Changes

Rebalance when:

• Approaching retirement (reduce risk)
• Major life events (marriage, children)
• Changing goals
• Risk tolerance changes

Conclusion

Rebalancing is an essential portfolio management tool that:

• Maintains your target risk profile
• Enforces disciplined investing
• Can improve long-term returns
• Keeps you on track with goals

Key Takeaways:

• Rebalance annually or when allocations drift 5%+
• Use new money when possible to avoid CGT
• Stick to your strategy - avoid emotional decisions
• Consider all costs (brokerage, taxes)
• Keep it simple - don't overcomplicate

Best Practices:

• Set a rebalancing schedule
• Use threshold-based triggers
• Prefer new money over selling
• Consider tax implications
• Stay disciplined

Remember, rebalancing is about maintaining your strategy, not market timing. Regular, systematic rebalancing helps you stay on track toward your investment goals while managing risk effectively.

The frequency and method depend on your situation, but most investors find annual rebalancing with a 5% threshold works well. Start simple, stay consistent, and let rebalancing work as a tool to maintain your investment discipline.