Many people who manage their own portfolios often don't have a systematic process to tell them when to rebalance. There are many factors which come into play when deciding whether or not to sell a security such as risk tolerance and tax efficiency. Sometimes, the trend may continue over your rebalancing point, but following a system of taking profits at a specified point can be a great way to profit off of the normal variations in price and miss some corrections.

Since 2000, the average annual return of Vanguard 500 Index Inv (MUTF:VFINX) is 5.89% with a standard deviation of 19.66%. The high standard deviation is reflective of the two recessions during this time period. The cyclicality of price movements is a reason for having this systematic approach. Keeping your desired asset allocation also is a great way to manage risk. Without rebalancing, a portfolio can become overweight in a certain asset class, which may be too risky for an investor, or vice versa.

The 60/40 portfolio of Vanguard S&P 500 ETF Index Fund Inv and VBMFX with an initial $1,000,000 investment and no rebalancing would have an after tax balance of $1,940,335 at the beginning of 2016.

Since VFINX has a much higher standard deviation than the bond fund, the movements will be of much greater magnitude and can be taken advantage of, while VBMFX is much more stable. Tactical asset allocation allows for each asset class to be in a range of percentages of your total portfolio. For example, if you want your 60/40 portfolio to stay in a +/- 5% range at all times, you will sell when the equity reaches 65.1% to bring it down to 60%. The purpose of this is to keep allocation consistent with your risk portfolio and possibly take advantage of the cyclicality and variations of the market. A percentage as low as 5% is more about downside protection than market timing. In a range around 8%-15% for equities, you can outperform a simple holding strategy. The size of the tactical bands depends on the standard deviation because the normal percent gain or decline is often followed by movement in the opposite direction.

With 5% tactical bands on both the equity and fixed income portions of your portfolio, the total return jumps up to $2,317,806 after tax in the beginning of 2016 after the initial investment of $1,000,000 in 2000. Rebalancing occurs six separate times in the period and results in almost 20% higher than without rebalancing.

If you increase the percentage to 8 on both sides, the value increases to $2,575,765, with only four rebalances, an 11% increase from the 5% tactical bands.

Now the largest performance increase comes with a wider band for equities and tighter for fixed income. In this particular case, the best performance came with a 12% range for VFINX and 3% for VBMFX, the total value increases to $2,854,903, with only four rebalances during the period, a 10.4% increase from the 8% range and 47% higher than without rebalancing.

The ending weight of the portfolio is 70.95% VFINX and 29.05% VBMFX, so using a range of this width would only be suitable for an investor who feels comfortable with a larger change in their asset allocation and more risk. All of this can be done using simple Excel logic and can be used for any time period, not just annually. The calculation used for the amount to rebalance is =if(equity % of portfolio > highest end of accepted range, withdraw equity value - (total portfolio amount * desired % of equity value of total portfolio),0). This model assumes that 10% of gains are taxed annually and a 15% long-term capital gains tax rate.

This can also be done successfully for a fully equity portfolio. The only difference is that the Excel formula is a little different because there is more than one option. The formula I use states that any allocation over the acceptable limit gets withdrawn, taxed, and assigned to the underweight assets to bring the percentages back to where they are desired. You can either put the money that is making the allocation overweight to cash and wait for an asset to go below your range or add it immediately; the latter is what I used in my model. Below are the charts for an equally weighted portfolio consisting of Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), and Johnson & Johnson (NYSE:JNJ) for a five-year investment starting at $1,000,000 within two different scenarios.

This is the graph showing the value with no rebalancing. The total value on May 19, 2017 is $3,165,353 and an ending weight distribution of 15.08%, 34.36%, 34.76%, and 15.80% (AAPL, FB, AMZN, JNJ). The profit over the five years comes to 216%, but let's see if a rebalancing strategy can make a difference. After testing many different ranges, rebalancing almost always results in a higher profit after tax.

Tactical bands set 8% apart had a very impressive return. This range resulted in about one rebalance a year, so the tax consequences are also minor.

The ending value from this range came to $3,329,930, or a 5% increase from the portfolio without rebalancing.

Portfolio rebalancing can be a very valuable practice for both risk and profits. Now, my model is not perfect for everyone nor every situation, but rather it is just an example of how tactical rebalancing works. Having a systematic process to make decisions for you is the best way to take any emotion out and invest based on the numbers.

**Disclosure:** I am/we are long AAPL, FB, AMZN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.