Rebalancing

A deeper-level theme (developed fully at Level III, but worth knowing) is what sizes the tolerance band around each target weight. Higher transaction costs, higher risk tolerance, and higher correlation with the rest of the portfolio all argue for a wider band; higher asset volatility argues for a narrower one, since a volatile asset drifts past target faster. Tax matters too: a taxable account favors wider bands to defer realizing gains, whereas a tax-exempt account can rebalance more tightly. Most of these belong to asset-allocation, not the Level I core, so treat them as concept, not formula.

The classic trap is conflating rebalancing with a tactical shift. Rebalancing returns the portfolio to the strategic (policy) weights — it never chases a new view; tactical allocation deliberately departs from those weights to exploit perceived mispricing. And it is not “buy-high, sell-low”: it is the opposite, a disciplined sell-the-winners, buy-the-losers rule — a bet on mean reversion.