Portfolio Rebalancing

Rebalancing is the discipline of returning a portfolio to its target allocation after the weights drift. A 60/40 split of shares and bonds drifts as the two grow at different rates, and the drift changes the risk the portfolio carries - the split was the decision, and the drift quietly undoes it. The two standard approaches are the calendar version - rebalance every year, on a date - and the threshold version - rebalance when any weight moves more than 5 percent from target.

The Australian tax detail decides where the rebalancing happens. Rebalancing a personal brokerage portfolio realises capital gains and triggers CGT - every trade is a disposal, with or without the 50 percent discount. Inside super, the same trades carry no personal CGT events, and new contributions can do the rebalancing for free by flowing into the underweight asset. The asset class entry covers the split the drift moves, and the diversification entry covers what the drift does to it.

The drift is the mechanism. Start at 60/40 - $60,000 in shares, $40,000 in bonds. Shares rise 20 percent to $72,000 and bonds stay flat; the total is $112,000 and the weights are 64/36. The portfolio now carries more equity risk than the split that was chosen, and the drawdown that follows will land on the larger base. The drift is invisible on the statement and visible in the risk.

The rebalancing trade is the second mechanism. Selling $4,800 of shares and buying $4,800 of bonds returns the split to 60/40 - $67,200 and $44,800 on the $112,000 total. The trade sells the winner and buys the loser, which is why it feels wrong and works: the weights return to the risk that was chosen, and the discipline is the mechanical version of selling high and buying low. The calendar version does it once a year; the threshold version does it whenever a weight moves 5 percent from target.

The tax is the third mechanism, and the Australian one. The same $4,800 trade in a brokerage account realises a gain, and at a discounted effective rate of 16 percent the tax is $768; a decade of annual rebalancing realising $10,000 of gains a year costs roughly $16,000 of tax. Inside super the same trades carry no personal CGT events, and directing new contributions to the underweight asset rebalances without a single trade. The portfolio rebalancing calculator runs both versions on any split.

For an Australian reader, rebalancing is the maintenance the allocation needs, and the location is the decision that decides the tax bill. The brokerage version triggers CGT on every trade; the super version does not, and the contribution version does not even trade. The capital gains tax entry covers the discount the brokerage version triggers. MoneySmart's guidance treats the asset allocation as the biggest decision in a portfolio, and rebalancing is what keeps that decision intact.

A colleague named Brent (yes, that Brent) rebalanced his brokerage portfolio every quarter, because the mechanic felt like vigilance. Each quarter realised gains, and the CGT on a decade of quarterly trades ran to five figures - a tax bill for a discipline the same trades would have cost nothing inside super. The highest-leverage thing most Australians can do is rebalance inside super or with new contributions, pick the calendar or the threshold and hold it, and run the portfolio rebalancing calculator on the split before the next trade. The vigilance is not the discipline; the location is.