Let’s say that late last April (2011) you decided that an appropriate asset allocation for you, based on your risk tolerance, was 50% stocks and 50% bonds, and that you preferred a very simple portfolio using only 2 asset classes: US Stocks and US Bonds. So, on May 2, you invested $20,000 by buying $10,000 of Vanguard Total Stock Market Index fund and $10,000 of Vanguard Total Bond Market Index fund. About three months later, on August 8, the stock fund had declined in value to about $8,150, the bond fund had increased in value to about $10,380 (assuming reinvested dividends), and your total portfolio was worth about $18,530 (data from morningstar.com). At that point your portfolio was 44% stocks and 56% bonds; i.e., each asset class was about 6 percentage points away from it’s target allocation of 50%.
Assuming no changes in your risk tolerance or other factors affecting your desired asset allocation, you would have been wise to consider rebalancing your portfolio back to its target asset allocation of 50% stocks and 50% bonds. This could have been done by exchanging an appropriate amount from the bond fund to the stock fund (exchanging is a way to simultaneously sell shares of one fund and buy the same dollar amount of shares of another fund). With a portfolio value of $18,530, you would have wanted $9,265 in each fund, so you would have exchanged $1,115 from the bond fund to the stock fund.