What it means
Prices rarely move in a straight line. A share price jumps up and down from day to day, but over months or years it may trend gently in one direction, which is the drift.
Imagine a boat on a river: the waves toss it around, but the current carries it slowly downstream. In quantitative finance, drift is one of the two main ingredients of a price model.
The first ingredient is the expected return, or drift, and the second is volatility, which measures the size of the random swings around that trend. A stock with an 8% drift and 20% volatility is expected to rise by about 8% a year on average, but its actual path can look very different.
Drift matters when valuing options and forecasting returns. In the pricing models used for options, a special assumption called risk-neutral drift replaces the real expected return, because the option's value does not depend on investors' appetite for risk.
Forecasters estimating future wealth or budgets usually use an assumed drift based on historical averages and judgement. There is a second, more practical meaning for investors.
Style drift happens when a fund manager gradually changes the kind of investments in a fund, for example a small-company fund that buys larger companies as it grows. Allocation drift happens when market movements shift a portfolio away from its target mix, such as 60% shares and 40% bonds becoming 70% and 30% after a rally.
The remedy for allocation drift is rebalancing, which means selling some of what has risen and buying what has fallen to restore the target. Investors check for style drift by reading fund reports and comparing a fund's holdings with its stated approach.
Left unchecked, drift can increase risk without the investor noticing.
In practice
Real-world examples.
Example
A portfolio worth $500,000 is meant to hold 60% shares and 40% bonds. After a strong stock market, the mix has drifted to 70% shares and 30% bonds. The investor sells $50,000 of shares and buys bonds to return to the target.
Example
An investor notices that a small-company fund has been buying much larger companies over three years. The fund's manager says that the changes reflect opportunities, but the investor feels the fund no longer matches its description. She moves her money to a fund that has kept its style.
Example
A risk analyst builds a simple model to project the value of a pension fund. She assumes a drift of 6% a year and volatility of 12%. She runs thousands of simulations to show a range of possible outcomes.
Formula
Calculation
Average drift per period = (Ending price - Starting price) / Number of periods
Worked example: a share price moves from $50 to $52 over 20 trading days, though it rises and falls on individual days.
Step 1: Total change = $52 - $50 = $2
Step 2: Average drift per day = $2 / 20 = $0.10
Step 3: As a percentage of the starting price, the total drift = $2 / $50 = 4% over the 20 days
In a formal model, the drift rate is usually written as mu and is the expected return per year, so an 8% drift means the price is expected to grow by about $8 a year on a $100 share.Case study
Seen in the real world.
Ashgrove Retirement Services is an illustrative, fictional adviser that set up a balanced portfolio for a client with a target of 50% shares and 50% bonds worth $400,000. The client never reviewed the account after the initial set-up.
Over four years, shares did well and bonds were flat, and the portfolio drifted to 68% shares and 32% bonds. When a market fall of 20% in shares occurred, the client lost about $54,400 on the equity part, which was a larger share of the portfolio than planned.
The adviser introduced an annual rebalancing rule that restores the target whenever any asset class is more than 5 percentage points away. The illustrative lesson is that drift is gentle and easy to ignore, but it can quietly raise risk.
Watch out
Common mistakes.
- Assuming prices move in a straight line, when drift is only the average direction beneath constant random swings.
- Ignoring allocation drift, when a rising market can leave a portfolio far riskier than intended.
- Treating historical drift as a promise, when the future average return may be very different.
Questions
People also ask.
What is the difference between drift and volatility?
Drift is the average direction of movement, while volatility measures how far prices swing around that direction.
What is style drift?
It is when a fund gradually changes the type of investments it holds so that it no longer matches its stated strategy.
How can I control portfolio drift?
You can rebalance on a schedule, such as once a year, or when an asset class moves beyond a set tolerance from its target.
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