Over time, share allocations drift naturally: appreciated asset classes gain more weight than planned. A portfolio designed as moderate can become aggressive after a stock market rise without any investor action — and at this exact moment it becomes most vulnerable to a reversal.
Rebalancing restores the original proportions: some of the appreciated assets are sold, and underperforming ones are bought. Mechanically, this means selling during rallies and buying during declines — the opposite of natural market instinct.
It is typically performed according to a predetermined rule: either at fixed intervals or when allocation drifts beyond a set threshold. The rule itself matters more than the method, as it protects against emotion-driven decisions both during prolonged rallies and bear markets.
Practical constraints exist: each transaction carries costs, and selling illiquid instruments may be unfavorable. Therefore, excessively frequent rebalancing is counterproductive, and threshold levels should be set considering portfolio size and transaction costs.