Rebalancing is an investment technique that helps enforce discipline, maintain desired allocations, and continually buy low and sell high.

The specific process:

1. Set desired asset allocation percentages

2. Determine the trigger that will cause you to rebalance. For instance, you might:

3. Whenever rebalancing is triggered, securities that represent a higher proportion of the portfolio than originally allocated are sold off to bring the percentage back in line. Securities that are underweighted according to that allocation are purchased to bring their percentages back in line.

As an example, imagine a portfolio of $100,000 consisting of two mutual funds, fund A and fund B, each priced at $10 per share when this scenario starts. Assume that a 50% allocation in each is deemed appropriate. Thus $50,000 is used to buy 5,000 shares of each fund, rendering $50,000, or 50% of the account, in each fund.

Time passes, and fund A does better than B such that fund A is now 52% of the portfolio and fund B is only 48%. To keep the math easy, assume the portfolio is still worth $100,000 with new share prices of $10.40 and $9.60 for A and B respectively.

To rebalance, the investor would sell $2,000 worth of fund A and buy $2,000 worth of fund B, bringing each to the original allocation of 50%. Interestingly, selling A at $10.40 requires the liquidation of only 192.31 shares while buying B at $9.60 allows for the purchase of 208.33 shares.

Note that if the share prices of both returned to their original $10 value, this investor would have $100,160.20, an extra $160.20 simply by rebalancing. In addition to keeping portfolio allocations in line, the continuous process of marginally buying low and selling high can add substantially to returns.