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Lesson 2 of 13 · 13 min
Portfolio returns over time: drift and rebalancing
Over several periods a portfolio's return depends on how its weights evolve: left alone, winners grow into bigger weights (portfolio drift), so the realised return differs from the fixed-weight one.
In short
- Portfolio statistics can be historical (from realised returns) or forward looking (model-based forecasts); history guides forecasts but can mislead.
- A period's portfolio return is the sum of beginning-of-period weights times the assets' returns over that period.
- With no rebalancing, a portfolio's cumulative return equals the initial weights times each asset's own cumulative (compounded) return.
- The arithmetic average of period returns ignores compounding; the geometric average compounds and is never higher.
- Portfolio drift: weights move as assets out- or underperform. Style drift: the portfolio's character moves away from its strategy. A set rebalancing schedule keeps both in check.
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