By Paul Weisbruch of Street One Financial

ETF investors -- retail and institutional -- as well as investment advisers using exchange-traded funds in their client portfolios likely use portfolio-rebalancing periodically. Some advisers prefer to weight their client portfolios to favor value over growth and then rebalance the portfolios to bring their weightings in line with their original targets.

One simplistic example is an adviser who uses a 60-40 value-to-growth split in client portfolios and rebalances once per year in December. If during the following year value stocks are in vogue in the market, this 60% value to 40% growth could look like 70-30 or even 80-20. That is because some stocks, or ETFs, will rise in value, others will fall, some will remain stagnant and the original "model weightings" will rarely be in line with the initial targets after market forces go to work and take over. Thus, a rebalance may consist of taking profits on those holdings that have run the furthest and reinvesting those profits by buying more shares of those holdings in the portfolio that underperformed.

>>Want More ETFs? Visit Our ETF Screener Page

Others may rebalance by buying their winners and selling their losers, in essence doubling up on those stocks or ETFs that have fared the best in the previous period and dumping the underperformers. With a rebalancing schedule, one is adding an element of active management to a portfolio of index ETFs and likely attempting to add value in terms of alpha to his or her stated benchmarks. Many individual investors employ an investment adviser so that these rebalance needs are met systematically and professionally, and it pays to understand how different ETF index methodologies work so that they can aid the investor's rebalancing expectations and trading decisions.

Let's start with the basic "market-cap weighted" indices, like the S&P 500, S&P 400, S&P 600, Russell 1000 and Russell 2000. The index mechanisms are fairly simple. The weightings of the stocks included in these indexes are individually determined by the stock's price, multiplied by shares outstanding, otherwise known as market capitalization. Therefore, stocks that have a large number of shares outstanding or a high stock price tend to dominate the upper part of the index weightings, so market-cap weighted indices tend to have a large-cap bias.

If you liked this article you might like

Market Is on the Straight and (Very) Narrow

Look Back to Go Forward

Stock Observations; Reviewing Equities: Doug Kass' Views

Even North Korea's Kim Jong Un Can't Stop This Epic S&P 500 Stock Rally

Robots Might Be Biggest Obstacle for Stock Market Bears