Assuming you have your portfolio in place, and perhaps regularly adding to it, you will see that your asset allocation will move away from the set ratios and this is because the assets would grow at different rates. Hence, the need to rebalance.
Rebalancing is simply your attempt to keep your portfolio in line with your asset allocation – risk appetite and other objectives/constraints. It also provides an opportunity to review the investments within each asset class, to ensure they are still in alignment with your investment goals.
Often it is the winning assets that go over the set limits in terms of allocation and the temptation is to keep things that way. While rebalancing could mean that you give up some gains by reducing your winning positions, it would however keep you from big losses if they go south.
In any case, reducing your holdings in current winners and increasing you holdings in current losers, allows you to actually buy low and sell high. However, when rebalancing, i have a preference for adjusting investments in such a way that new funds go more into the purchase of asset classes that have dropped below their limits, until your portfolio is back in line. This way you don’t have to sell your securities and event that would lead to transaction costs and capital gain taxes (not capital gains tax in Nigeria at the moment).
A rebalance should be done every 6 or 12 months. You could also rebalance when asset allocation limits have moved sharply away from the pre-set limits.