Two Assets Went Nowhere. Your Portfolio Still Grew 17%. How the Rebalancing Bonus Works
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5 min read
Picture two investments. Over two years, neither one gains a single rupiah. Each ends exactly where it started.
Now put half your money in each and tidy the mix once a year. In the example below, your Rp 100,000,000 grows to about Rp 117,400,000. That gain is the rebalancing bonus: extra return that comes from the act of rebalancing, not from either asset winning.
It sounds like a trick. It is real arithmetic, and it comes with strict limits. This post shows the numbers, then shows when the bonus disappears.
Rebalancing means selling a bit of what rose and buying a bit of what fell, to return to your chosen split, such as 50% and 50%.
The rebalancing bonus is the extra compound return a rebalanced mix can earn compared with the simple average of its parts. It is also called volatility harvesting, because it feeds on price swings. Booth and Fama named a close cousin of the idea "diversification return" in 1992. William Bernstein popularised the term in his monograph "The Rebalancing Bonus".
Volatility here just means how much a price bounces up and down.
These numbers are made up on purpose. They are a teaching tool, not a forecast of any real asset.
Asset X and Asset Y swing in opposite directions. When X rises 50%, Y falls 33.3%. The next year they flip.
| Year | Asset X | Asset Y |
|---|---|---|
| 1 | +50% | −33.3% |
| 2 | −33.3% | +50% |
Check each one alone. A +50% year takes Rp 100 to Rp 150. A −33.3% year takes Rp 150 back to Rp 100. So both assets end flat after two years.
Now compare two ways of holding a 50/50 mix of Rp 100,000,000.
| After | Never rebalance | Rebalance to 50/50 each year |
|---|---|---|
| Year 1 | Rp 100,000,000 | Rp 108,333,333 |
| Year 2 | Rp 100,000,000 | Rp 117,361,111 |
Why does the right-hand column grow? Each year, half your money rises 50% and half falls 33.3%. The average of those is +8.33%. Rebalancing resets the split, so the next year again puts half your money into each swing. You earn that +8.33% average every year, instead of letting one big loss shrink the base.
If you want the background on that gap, read our guide to arithmetic vs geometric mean return. The bonus is the same effect, put to work.
The bonus is not free money. It needs three things to be true.
1. Prices must swing and then come back. The bonus feeds on assets that rise and fall in turn. If one asset simply climbs while the other lags, rebalancing means selling the winner too early.
Here is the same test with steady trends. Asset X gains 20% a year. Asset Y gains 5% a year. Start with Rp 100,000,000 split 50/50 and run two years.
| After 2 years | Result |
|---|---|
| Never rebalance | Rp 127,125,000 |
| Rebalance each year | Rp 126,562,500 |
Rebalancing finished slightly behind, because it kept trimming the faster horse.
2. The assets must not move in lockstep. If two assets rise and fall together, there is no winner to sell and no laggard to buy. The bonus shrinks toward zero.
3. Costs must stay small. Every sale can carry broker fees and, in some cases, tax. A small bonus can be wiped out by frequent trading. Our post on how often to rebalance covers the cost side.
Do not expect a big free lunch from real markets. Vanguard tested a portfolio of 60% US stocks and 40% US bonds on data from 1926 to 2009. Per summaries of its 2010 paper "Best Practices for Portfolio Rebalancing", the portfolio rebalanced once a year returned 8.6% a year. The one never rebalanced returned 9.1%.
So rebalancing did not raise the return there. The never-rebalanced mix also drifted from 60% stocks to over 84% stocks, which is a much riskier portfolio than the one the investor chose.
That is the honest takeaway. In real life the main job of rebalancing is keeping your risk where you set it. The rebalancing bonus is a real effect, but it is a small one that depends on how prices behave.
Note: we could not open Vanguard's PDF directly. The figures above come from several published summaries of it, so check the paper itself before relying on them.
Your portfolio may have drifted far from the split you meant to hold. Open the Holdings page and compare each sleeve's weight with your target. If one has swung a lot, you can see how much a rebalance would move.
For a view of how much markets are bouncing right now, the Market page shows current volatility across Indonesian, US and crypto markets.