Key Takeaways
- Portfolio rebalancing means returning your investments to a target asset mix after market movements change their weights.
- Common approaches are calendar rebalancing, threshold rebalancing, and cash flow rebalancing, each with pros and cons.
- Rebalancing helps manage risk and keeps your portfolio aligned with your goals, but it can create taxes and trading costs.
- A simple step-by-step method: review allocation, measure drift, decide method, execute trades or use new contributions, and document the action.
- Use examples like a 60/40 stocks/bonds portfolio or a multi-fund ETF mix to practice rebalancing with real numbers.
Introduction
Portfolio rebalancing is the process of adjusting the proportions of assets in your investment portfolio so they match your target allocation. It's a maintenance task that keeps your risk level consistent with your financial plan as markets move your holdings away from the intended mix.
Why does this matter to you? If stocks run up and become a bigger share of your portfolio, you may be taking on more risk than you planned. If bonds outperform, you might be too conservative. Rebalancing brings your holdings back to the allocation you chose based on your goals and time horizon.
In this guide you'll learn what rebalancing is, when to do it, the most common methods, a clear step-by-step process you can follow, real-world examples with tickers, tax and cost considerations, and common mistakes to avoid. Ready to get your portfolio back on track?
What Is Portfolio Rebalancing?
Rebalancing means selling some assets and buying others, or directing new money, to restore your chosen allocation. For example, if your target is 60 percent stocks and 40 percent bonds, rebalancing moves those percentages back to 60/40 after market swings cause them to drift.
This process can be mechanical, based on rules like a calendar date or a percentage threshold, or it can be discretionary, driven by changes in your goals or market outlook. The key idea is keeping your risk exposure aligned with your plan, not trying to time the market.
Why Rebalance and How Often?
Rebalancing helps manage risk. When one asset class outperforms, your portfolio can become concentrated in that area. That concentration raises volatility and potential losses if the trend reverses. By rebalancing, you systematically sell some of the winners and buy some of the laggards, a form of disciplined buying low and selling high.
How often should you rebalance? There is no single right answer. Typical approaches include calendar-based schedules such as quarterly or yearly checks, and threshold-based rules that trigger rebalancing when an asset class moves a set percentage away from its target, commonly 5 percentage points.
Common schedules and tradeoffs
- Quarterly or annual rebalancing, easy to follow, may reduce trading frequency but can allow larger drift.
- Threshold rebalancing, for example rebalance when any allocation is 5 percent off target, keeps allocations tighter but can increase trades.
- Hybrid approach, check quarterly but only trade if thresholds are exceeded, balances costs and control.
Step-by-Step Rebalancing Process
This section gives a practical, beginner-friendly workflow you can use the next time you rebalance. Keep it as a checklist you revisit each period.
1. Confirm your target allocation
Before you rebalance, know your target. Common targets are 60 percent stocks and 40 percent bonds for moderate risk, or 80/20 for higher risk. Your target should reflect your time horizon, risk tolerance, and financial goals.
2. Measure current allocation and drift
Calculate the market value of each holding and divide by portfolio value to find current percentages. For example, in a $100,000 portfolio with $65,000 in stock ETFs and $35,000 in bond funds, you have 65 percent stocks and 35 percent bonds, a 5 percent drift from a 60/40 target.
3. Choose a rebalancing method
Decide whether you will sell winners and buy laggards, use new contributions to fix the mix, or rebalance via tax-efficient trades in specific accounts. Use the method that fits your tax situation and trading costs.
4. Execute the trades
If you rebalance by trading, calculate the amount to buy or sell to reach target percentages. Example: If you want to go from 65/35 back to 60/40 in a $100,000 portfolio, sell $5,000 of stocks and buy $5,000 of bonds. If you use new contributions, direct future deposits to the underweight asset until the target is reached.
5. Record and review
Document the date, the trades, fees, and any tax consequences. Review results at your next scheduled check so you can refine thresholds and methods over time.
Rebalancing Methods and Tools
There are several practical methods you can use. Each has advantages depending on account type, tax considerations, and how hands-on you want to be.
Sell-to-rebalance
This is the direct approach where you sell portions of assets that are over target and buy the ones that are under target. It's simple, but it can generate taxable events in taxable accounts.
Use new contributions
When you have fresh cash to invest, channel it to underweight assets until the allocation returns to target. This avoids selling winners and can be tax efficient, but it can take longer to correct large drifts.
Tax-aware rebalancing
In taxable brokerage accounts, prefer using losses to offset gains before selling winners. Use tax-advantaged accounts like IRAs and 401(k)s for trades that would otherwise create tax bills. Consider leaving short-term winners alone if selling would trigger higher short-term capital gains taxes.
Automatic rebalancing tools
Many robo-advisors and some brokerage platforms offer automatic rebalancing. This is a good option if you prefer a rules-based approach without manual trades. Check platform fees and how often they rebalance.
Real-World Examples
Examples make rebalancing concrete. Below are two realistic scenarios you can model with your own numbers.
Example 1: Simple 60/40 portfolio
Target: 60% stocks (via $VOO), 40% bonds (via $BND). Portfolio value: $150,000. Stocks now $100,000, bonds $50,000. Current allocation: 67% stocks, 33% bonds.
Drift: Stocks are 7 percentage points above target. To rebalance back to 60/40, target stock dollar amount is 0.60 times $150,000 equals $90,000. Sell $10,000 of $VOO and buy $10,000 of $BND. Account for trading costs and bid/ask spreads if any.
Example 2: Multi-ETF allocation with new contributions
Target: 50% US stocks ($VTI), 20% international stocks ($VXUS), 25% bonds ($BND), 5% cash. Portfolio value: $50,000. Current values have drifted so US stocks are 56 percent and bonds 19 percent.
If you have $1,000 to add each month, direct new money to underweight funds, like $BND and $VXUS, until the allocation returns closer to target. This avoids selling and keeps taxes minimal.
Costs, Taxes, and Practical Considerations
Rebalancing has tradeoffs. Transactions can create commissions, bid/ask costs, and taxable events. Plan around these to keep more of your returns.
In taxable accounts, selling appreciated assets creates capital gains. Long-term capital gains rates are usually lower than short-term rates, so holding for more than a year before selling may reduce taxes. Use tax loss harvesting when possible to offset gains with losses.
Also consider minimum trade sizes and spread costs for some ETFs or small positions. If selling would leave very small residual lots, think about consolidating to avoid unnecessary complexity.
Common Mistakes to Avoid
- Rebalancing too often: Trading every week raises costs and may produce small benefits. Use sensible thresholds or schedule rebalances quarterly or annually unless a large drift occurs.
- Ignoring tax consequences: Selling winners in taxable accounts can trigger taxes. Coordinate rebalancing with tax-aware strategies like using losses or rebalancing inside retirement accounts.
- Chasing performance: Rebalancing is not about picking hot sectors. Avoid changing targets based on recent winners or media hype, unless your goals or risk tolerance changed.
- Overcomplicating allocations: Using dozens of tiny funds makes rebalancing tedious. Keep the core allocation simple with broad ETFs like $VOO, $VTI, and $BND before adding specialized positions.
- Forgetting to document: Not recording why and how you rebalanced makes it hard to learn from past actions. Keep a simple log of dates, trades, and reasons.
FAQ
Q: How often should I rebalance my portfolio?
A: There's no one-size-fits-all answer. Many investors rebalance annually or quarterly, while others use a threshold like 5 percentage points of drift. A hybrid approach, where you check quarterly but only trade when the drift exceeds a threshold, is a practical balance between cost and control.
Q: Should I rebalance during market volatility or wait?
A: Rebalancing during high volatility is often appropriate if your allocations have drifted significantly. Volatility alone is not a reason to change your target. If a major life event changed your goals, then adjust the target allocation first, then rebalance to match.
Q: Can I rebalance using only new contributions?
A: Yes, using new contributions to buy underweight assets is tax-efficient and cost-effective. It works well if you have regular contributions and the drift is moderate. Large drifts may require selling winners to restore balance faster.
Q: Does rebalancing improve returns?
A: Rebalancing does not guarantee higher returns, but it helps manage risk by keeping your portfolio aligned with your plan. Over the long run, disciplined rebalancing can improve risk-adjusted returns by preventing overconcentration in a single asset class.
Bottom Line
Rebalancing is a simple but powerful habit that keeps your portfolio aligned with your financial goals and risk tolerance. Whether you follow a calendar, use thresholds, or rely on automatic tools, the important part is having a clear plan and following it consistently.
Action steps you can take today: confirm your target allocation, calculate current percentages, pick a rebalancing rule, and decide how to execute trades while considering taxes and costs. Keep a short log, and review your approach yearly to improve the process as your situation evolves.
At the end of the day, rebalancing is about discipline, not timing the market. If you set a simple rule and stick to it, you’ll be much more likely to keep your investments on track as markets move.
