Rebalancing means you actively respond to the market and it therefore has no place in any passive investment strategy

Hi,

when I talk about “passive investing” I mean the classical strategy of picking 1-4 diversified ETFs and then buying a fixed amount in regular intervals. This fixed amount naturally results in a “target allocation”, e.g. 90% A and 10% B. Now, what people parrot everywhere is that you have to “rebalance your portfolio to meet your target allocation”. Like, once per year or whatever. But this doesn't make any sense in passive investing!

Passive investing is all about acknowledging that you can't predict the market. That you can't time he market, that you don't know anything the market doesn't know as well. Passive investing is about picking something reasonably diversified, picking monthly rates and then that's it. In this context, there is no sane argument in favor of regular rebalancing.

• “You need to reduce the risk, you are no longer diversified”:

You only stop being diversified when the market decides that one position should grow faster than the rest of your portfolio. The only risk here is to lose what you previously gained. The market giveth, the market taketh. If I regularly invest 90% into SPY and 10% into Nvidia, then that's my risk exposure. The risk doesn't increase when Nvidia growths faster than SPY. At any point, I can only lose 10% of my investable capital if Nvidia dies. Your real risk comes from your monthly rate allocation, not from whatever allocation results from the market movements.

• “You need to lock in the gains”:

Timing the market, are we? It appears to make sense, granted. Your target allocation is 90/10, now it turned to 70/30, so you sell some and buy some to bring it back to 90/10. But, as stated above, you are not lowering any risk exposure here. Second, you are flipping a coin. Maybe rebalancing turns out to be financially the right thing to do, maybe not. You can not predict this. Anyone arguing that rebalancing helps to “lock on the gains” is trying to predict the market:

• “It's better to only buy one ETF to avoid rebalancing”:

This might be the worst of them all. Commonly heard in European subs when it's about ACWI vs World + EM. The ACWI is an index that contains first world and emerging markets. World and EM are indexes that separate these two. If I buy the ACWI, I can't rebalance anything since it's just one single ETF. If I buy World and EM separately, I could rebalance, if I wanted to. But there is no reason to! If the emerging markets grow faster, their percentage within the ACWI increases. And their percentage increases in exact the same way if I would hold the World and the EM separately. Why on earth would I try to fight the market in the second case? And why on earth would I decide to fight the market, create an outcome that would be different to holding 100% ACWI, and then use this process as argument to hold the ACWI? Doesn't make any sense whatsoever.

TLDR: Rebalancing means trading, trading means you are not investing passively. Don't rebalance if you want to follow a passive investment strategy.