Rebalancing is one of the most widely accepted disciplines in portfolio management. Decide how much you want to allocate to each asset, allow markets to move, and periodically bring the portfolio back toward those original weights. The logic is appealing. It prevents a successful investment from gradually taking control of the portfolio, forces us to sell some assets after they have risen and buy others after they have fallen, and keeps the risk profile reasonably close to the one we originally chose.
There is nothing inherently wrong with this approach. But it contains an assumption that is rarely questioned: that the original percentage remains the right percentage simply because we chose it in the past.
That becomes particularly interesting when an investment was included precisely because it had the potential to produce an unusually large outcome.
Imagine a portfolio worth $100,000. The investor puts $25,000 into Bitcoin (Bitcoin is an extreme example, but the principle can apply to other assets as well) and the remaining $75,000 into more conventional assets. A 25% Bitcoin allocation is already aggressive. The investor understands the volatility and accepts the possibility of substantial losses because the asset also offers a return profile that may be very different from the rest of the portfolio.
Now imagine that Bitcoin performs extraordinarily well. The original $25,000 becomes $100,000 while, for simplicity, the rest of the portfolio remains worth $75,000.
The investor now owns $175,000 and Bitcoin represents approximately 57% of the portfolio.
From the perspective of traditional portfolio construction, something important has happened. The allocation is no longer 25%. Concentration risk has increased dramatically. The portfolio the investor owns today is not the portfolio originally designed.
The conventional response is obvious: rebalance.
But perhaps the decision is not quite as automatic as it appears.
What Exactly Has Gone Wrong?
When Bitcoin grew from $25,000 to $100,000, the investor did not transfer another $75,000 of savings into it. The additional exposure was created by the success of the investment itself.
That distinction does not make the $100,000 position less real. If Bitcoin falls from $100,000 to $50,000, the investor has lost $50,000 of genuine wealth. Calling it “house money” would be an accounting illusion. At $100,000, those dollars could have been sold, spent, diversified or used to finance years of future life.
But there is another fact that is equally real. The investor originally decided to expose $25,000 to an asset with unusually uncertain outcomes. If that decision succeeds spectacularly and the position subsequently falls 50%, the remaining $50,000 is still twice the original investment.
The same decline can therefore tell two stories at once.
Measured from the peak, $100,000 falling to $50,000 is a severe 50% drawdown. Measured across the entire investment experience, $25,000 becoming $50,000 is still a 100% gain. Neither measurement invalidates the other. They simply answer different questions.
This matters because we often use the first measurement to make decisions about the second.
A large drawdown tells us how much wealth disappeared from a previous maximum. Portfolio weight tells us how concentrated our wealth has become. Neither tells us automatically whether the investment has stopped serving the purpose for which we bought it.
Suppose the reason for allocating 25% to Bitcoin was precisely the possibility that a relatively limited initial commitment might eventually become a meaningful source of future wealth. If it succeeds, selling it repeatedly simply because it has exceeded 25% creates a peculiar result: the better the investment performs, the more aggressively we remove the outcome we originally hoped it might produce.
That does not make rebalancing irrational. It simply suggests that the target allocation may not deserve quite the authority we usually give it.
After all, 25% was not a law of nature. It was a decision made at a particular moment, with a particular amount of wealth, at a particular stage of life.
Why should that historical percentage automatically determine what happens to every dollar the investment subsequently creates?
The Difference Between Allocation and Dependence
The strongest argument for rebalancing is not that a percentage has moved. It is that our financial future may have become too dependent on a single uncertain outcome.
Those are related ideas, but they are not identical.
Consider the investor whose Bitcoin position has grown from $25,000 to $100,000. If this person is 35 years old, has stable income, substantial investments elsewhere and no intention of using the money for decades, allowing the position to remain large may be a risk they consciously choose to accept.
Now imagine exactly the same $100,000 position belongs to someone who plans to retire next year and needs that money to finance the first decade of retirement. The portfolio weight is identical. The significance of the risk is completely different.
The useful question is therefore not only, “What percentage of my portfolio is Bitcoin?” It is also, “How much of the life I am planning now depends on what Bitcoin does next?”
This applies beyond Bitcoin.
A founder may accumulate a large position in the company they helped build. An employee may receive shares that appreciate far beyond their original value. An investor may hold a stock purchased years earlier that becomes a much larger part of their wealth. Even a broad equity allocation can grow until it represents a much greater amount of money than the investor ever originally expected to place at market risk.
Percentage-based rebalancing treats these situations primarily as deviations from target weights. A purpose-based approach would ask what the accumulated wealth can now accomplish.
That distinction becomes increasingly important as wealth grows.
When $25,000 becomes $40,000, the additional wealth may not change the investor’s life very much. When it becomes $100,000, perhaps it begins to matter. If it eventually becomes $250,000 or $500,000, continuing to think only in terms of the original $25,000 becomes difficult to justify. The cost basis may explain how the wealth was created, but it does not determine what that wealth is worth today.
At some point, a successful investment may become capable of buying something more valuable than additional upside.
It might buy ten years of living expenses. It might eliminate the need to work until 65. It might fund a child’s education, pay off a mortgage or create a pool of capital that no longer needs to take significant risk.
That is a much stronger reason to sell than the fact that a spreadsheet says the position should be 25% and has become 37%.
When Capital Changes Jobs
This suggests a different way of thinking about rebalancing.
Instead of automatically moving capital whenever market prices change portfolio percentages, we can occasionally ask whether the job of that capital has changed.
Early in an investor’s life, a portion of capital may have one primary responsibility: create future wealth. The investor has time, income and the ability to recover from poor outcomes. Accepting volatility may therefore be entirely rational.
Years later, the same capital may have succeeded beyond expectations. What was once $25,000 of uncertain potential may now represent several years of financial independence.
At that point the investor does not necessarily need to sell because the asset has become “too large.” The investor may sell because some of the capital has completed its original assignment.
This is a subtle but important difference.
Imagine that the Bitcoin position eventually reaches $200,000. The investor could leave all of it exposed to future gains and losses. Or perhaps $100,000 could be moved into assets intended to finance future spending while the remaining $100,000 continues to participate in Bitcoin’s uncertain future.
The resulting allocation might still look extremely aggressive according to conventional portfolio rules. But the decision has a clear economic purpose. Part of an uncertain outcome has been converted into something the investor now values more: future certainty.
The trigger was not a percentage. It was utility.
This is also why refusing to rebalance can become just as mechanical as rebalancing itself. “I only invested $25,000 originally” is not a sufficient reason to expose $200,000 indefinitely if losing that money would materially change the investor’s life. Once gains become wealth, they deserve to be evaluated as wealth.
The relevant comparison is no longer between the current value and the original purchase price. It is between what the capital might become and what it can already do.
That is where investing begins to overlap with life planning.
A younger investor may rationally choose the possibility of substantially greater future wealth. Someone who has already accumulated enough to finance the life they wanted may rationally prefer to secure part of what has been achieved. Neither decision requires returning the asset to an arbitrary historical percentage.
The allocation can be a consequence of the decision rather than the reason for it.
Rebalancing Without Worshipping the Target
None of this makes traditional rebalancing obsolete. For many investors, maintaining relatively stable allocations is an excellent behavioral tool. It prevents portfolios from quietly becoming far riskier than their owners realize. It imposes discipline when greed makes selling difficult and provides a systematic way of buying assets after they have fallen.
For someone who does not want to make repeated discretionary decisions, those advantages are substantial.
But there is a difference between using target allocations as useful guardrails and treating them as permanent truths.
The original portfolio was constructed using information that existed at the time. Since then, markets may have changed, but so has the investor. Wealth may be greater. Retirement may be closer. Income may be different. Financial obligations may have disappeared. An asset that once represented an experiment may now represent financial independence.
It would be strange to insist that the correct response to all those changes is simply to restore the percentages selected years earlier.
The deeper purpose of portfolio management is not to preserve a pie chart. It is to allocate capital in a way that serves the investor’s objectives.
Sometimes that will mean rebalancing aggressively. Sometimes it will mean allowing a winner to become much larger than originally intended. And sometimes it will mean taking part of an extraordinary winner and moving it somewhere safer, not because its percentage has become uncomfortable but because the gain has become capable of financing something that matters.
A successful investment creates a new decision. It does not necessarily create an obligation to return to the old one.
Perhaps the most useful question when a winner becomes “too big” is therefore not how far it has moved from its target weight. It is what we would lose if it collapsed, what we could gain by allowing it to continue, and whether some of that capital can now purchase a form of freedom that future returns can no longer improve very much.
Rebalancing still has a place. But the portfolio should ultimately adapt to the life it is meant to finance, rather than requiring the life to remain permanently faithful to a percentage chosen years ago.
Leave a Reply