Bull-Market Rebalancing

Quick definition: Bull-market rebalancing forces you to sell outperforming assets and buy underperformers when everything is rising and the temptation to chase momentum is strongest.

Key Takeaways

• Bull-market rebalancing feels painful because you're constantly selling the best-performing asset (stocks) to buy the worst (bonds)
• This disciplined contrarian selling is precisely where bull-market rebalancing creates its edge, reducing concentration in overheated assets
• Extended bull markets naturally create allocation drift toward stocks, which increases portfolio risk at the worst time
• Rebalancing during bull markets provides the psychological foundation for maintaining discipline during subsequent bear markets
• The "opportunity cost" of missing a bull market's strongest gains is real but often overstated compared to the benefit of avoiding bubbles

The Counterintuitive Challenge of Bull-Market Rebalancing

If bear-market rebalancing is psychologically difficult, bull-market rebalancing is insidiously dangerous because it doesn't feel difficult at all—it feels like missing out. Your portfolio is rising magnificently, and rebalancing forces you to periodically sell the engine of those gains (stocks) to buy the laggard (bonds). Every rebalancing trade feels like you're intentionally hampering your returns.

This feeling is not entirely false. During a bull market, a pure equity portfolio will outperform a rebalanced 60/40 portfolio. From 2009 to 2021, an investor fully invested in stocks would have far exceeded the returns of someone mechanically rebalancing to maintain a 60/40 allocation. The gap is even more dramatic during the specific bull markets of 2013, 2017, and 2021, when stocks surged while bonds stagnated.

The question a rebalancing investor must confront during a bull market is this: Is the opportunity cost of rebalancing (missing some upside from stocks) worth paying to reduce the risk of holding too much in stocks when the market eventually reverses? History suggests the answer is yes, but the case is harder to make in real time during a raging bull market when risks feel invisible.

The Mechanism of Bull-Market Rebalancing

During a sustained bull market, the mechanical drift of a 60/40 portfolio is almost entirely toward stocks. Stocks appreciate faster than bonds (which might be rising slowly or even declining in value), so their portfolio weight increases. A 60/40 portfolio might drift to 65/35, then 70/30, and in extreme bull markets, even 75/25 or higher. Each rebalancing event forces the uncomfortable trade: sell stocks that are performing beautifully, buy bonds that are languishing.

Consider the bull market of 2017. The S&P 500 returned 21.8% that year while the Bloomberg Aggregate Bond Index returned 3.5%. A 60/40 portfolio holding its target allocation meant selling 4–5% of the portfolio's stock holdings and buying bonds at a 16 percentage point performance disadvantage. The performance drag was obvious: your bonds were a dead weight.

Yet that rebalancing proved prescient. In 2018, the market reversed sharply, with stocks declining 9.1% and bonds (benefiting from falling rates) returning 0.1%. A portfolio that had been fully invested in stocks (which would have reached 75% or 80% after 2017's gains) suffered a much larger decline than a rebalanced 60/40. The rebalancing in 2017, which felt foolish at the time, turned out to be the right decision when viewed through a broader lens.

This pattern repeats across bull markets. The rebalancing that feels most foolish—the one where you're selling the strongest performer and buying the weakest—is often the rebalancing that proves most valuable when the bull market ends.

The Concentration Risk of Drift

A subtle but important reason to maintain rebalancing discipline during bull markets is risk management. When stocks outperform and your allocation drifts toward 70%, 75%, or 80% equities, you've inadvertently increased your portfolio's concentration in a single asset class and your portfolio's sensitivity to equity market declines. This increased risk is precisely backward from prudent risk management.

During a bull market, risk feels low. Stocks are rising, correlations are positive, and the future appears bright. But risk and return are not the same as realized returns and sentiment. The risk of your portfolio (measured as standard deviation or downside vulnerability) has increased substantially with the shift toward higher equity allocation. The next bear market will reveal this risk painfully.

Consider a historical example. From 1995 to 1999, stocks returned approximately 28% annualized, while bonds returned approximately 5.5% annualized. An investor who simply held their drifting allocations without rebalancing would have found themselves at 80%+ equities by the end of 1999. This felt great in 1999, when stocks were soaring. But it felt terrible in 2000, when the technology crash wiped out 20–30%+ of portfolios heavily concentrated in equities. A rebalancer who had fought the bull market and sold stocks to buy bonds would have experienced a much smaller portfolio decline.

The temptation to ignore rebalancing during bull markets is strongest precisely when ignoring it is most dangerous. This is the nature of behavioral finance: the decisions that feel most correct often turn out to be the most costly.

The Psychology of Watching Others Outperform

A challenge specific to bull-market rebalancing is the psychological toll of watching peers and alternative strategies outperform. While you're mechanically rebalancing and underperforming a pure equity portfolio, others are shouting about their returns. A friend fully invested in stocks might be returning 25% annually while your balanced portfolio returns 15%. The gap feels significant, especially over consecutive years.

This phenomenon is particularly acute during "risk-on" periods when equities soar and everyone's risk tolerance increases. In such periods, it's easy to convince yourself that volatility is dead, that bull markets can continue indefinitely, that risk has fundamentally diminished. These narratives are seductive precisely because they're supported by short-term experience.

The historical experience of such periods is uniform: they end, often violently. The 1995–1999 bull market in technology ended with a three-year bear market. The 2003–2007 bull market ended with a financial crisis. The 2013–2017 bull market ended with a 9–10% correction. The 2018–2021 bull market ended with 2022's rate-driven decline.

Rebalancing discipline during these outperformance periods is psychological insurance. You're not just rebalancing your portfolio; you're insulating yourself from the worst of the behavioral traps that can undermine discipline. By regularly selling winners and buying losers, you're engaging in a discipline that's inherently contrarian and resistant to the groupthink that dominates bull markets.

Blending Bull-Market Rebalancing With New Contributions

A sophisticated approach to maintaining rebalancing discipline during bull markets, particularly for investors with ongoing contributions, is to direct new capital toward underweighted assets rather than rebalancing existing positions. For example, if your portfolio has drifted to 70/30 due to stock outperformance, your next contribution might be directed entirely toward bonds (instead of maintaining the 60/40 ratio), bringing your portfolio back toward target allocation.

This approach reduces the psychological pain of rebalancing because you're not forced to sell winners—you're merely channeling new growth toward laggards. It also reduces transaction costs and tax consequences compared to selling stocks and buying bonds. Over many years with consistent contributions, this approach can maintain target allocations without requiring explicit rebalancing.

However, this approach has limitations. If you have no ongoing contributions, or if contributions are small relative to portfolio size, directed contributions alone won't maintain target allocations. In such cases, explicit rebalancing becomes necessary. Additionally, relying entirely on directed contributions to avoid explicit rebalancing can undermine the contrarian discipline that rebalancing provides during extreme market dislocations.

The Mathematical Case for Bull-Market Rebalancing

Examining the mathematics of rebalancing over full bull-bear cycles illuminates why bull-market rebalancing, despite its drag on returns during the bull phase, creates superior long-term outcomes. Consider a 60/40 portfolio from 2009 to 2021:

• No rebalancing: A portfolio drifting from 60/40 in 2009 to approximately 80/20 by 2021 would have returned about 11.5% annualized but experienced higher volatility and a severe drawdown in 2020 and 2022.

• Annual rebalancing: A portfolio mechanically returning to 60/40 each year would have returned about 10.8% annualized but experienced lower volatility and smaller drawdowns in 2020 and 2022.

The return difference is approximately 0.7% annualized—the drag from rebalancing. But this ignores the value of lower volatility and smaller drawdowns. Using risk-adjusted measures, the rebalanced portfolio often shows superior performance. Moreover, if the analysis extends through 2023, when bonds recovered substantially, the rebalancing "drag" would have been offset and likely reversed.

This pattern—where rebalancing's cost appears during bull markets but its benefit materializes during downturns—is the fundamental reason why rebalancing works over long periods. You're not trying to beat bull markets; you're trying to avoid being devastated during the inevitable bear markets that follow.

Bull and Bear Market Rebalancing Cycle

The Discipline Foundation for Bear-Market Strength

A less obvious benefit of maintaining rebalancing discipline during bull markets is that it builds the psychological foundation for maintaining discipline during bear markets. An investor who has proven they can sell winners (stocks) and buy laggards (bonds) during a 2017-style bull market is far more likely to maintain rebalancing discipline in 2018 or 2022 when the market reverses.

Conversely, an investor who abandons rebalancing discipline during bull markets often loses it entirely during bear markets. They've already established a pattern of chasing momentum and abandoning mechanical rules when they feel wrong. Returning to discipline during the next bear market becomes psychologically impossible. The investor ends up selling low in the bear market (after momentum has turned against them) rather than buying low through rebalancing.

This suggests that bull-market rebalancing, while frustrating and apparently costly, is actually a crucial training ground for the rebalancing discipline that becomes most valuable during bear markets.

Horizon Considerations

The longer your investment horizon, the stronger the case for rebalancing discipline during bull markets. Investors with 30+ year horizons will experience multiple bull-bear cycles. The compounding benefit of missing the extremes of bubbles (through rebalancing during bull markets) and capturing the extremes of crashes (through rebalancing during bear markets) becomes substantial over such horizons. The opportunity cost of missing the strongest bull market years becomes trivial compared to the benefit of reducing drawdowns through multiple cycles.

Conversely, investors with shorter horizons might reasonably adopt more flexible approaches. An investor with a 5-year horizon and a bull market approaching their distribution date might choose to accept higher volatility and concentration in the final bull phase, knowing they won't be exposed to the subsequent bear market. However, most passive investors should assume a long horizon and maintain discipline accordingly.

Next Steps

Examine your recent rebalancing decisions. Have you maintained discipline during bull markets, or have you let allocations drift toward equities? If you've drifted, calculate what your current allocation is and establish a path to return to your target. If you've been rebalancing diligently, recognize that the frustration you feel watching underperformance relative to equity-only portfolios is the price of discipline—a price that history suggests is well worth paying. The next bear market will vindicate that discipline. Commit now to maintaining it through the next bull market, however tempting it is to abandon.

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Bull-market rebalancing disciplines you to sell the best-performing asset at its most euphoric price point, which is precisely the mechanism that allows rebalancing to add value across full market cycles.