Rebalancing Your Portfolio: When and How to Adjust Your Investments

• Rebalancing resets your portfolio to your intended asset allocation so your risk stays aligned with your goals.
• You can rebalance on a schedule (e.g., quarterly or yearly) or when allocations drift by a threshold (e.g., 5% or 10%).
• Simple, repeatable rules reduce emotional mistakes and can improve long-term risk-adjusted outcomes.
• Consider taxes, trading costs, and automatic rebalancing tools when choosing a method.
• Use concrete steps, measure, compare, trade, document, to rebalance efficiently and consistently.

Introduction

Rebalancing your portfolio means periodically adjusting your investments so they match your target asset allocation. For example, if you want 60% stocks and 40% bonds, rebalancing brings you back to that mix when market moves cause drift.

This matters because different assets carry different levels of risk and expected return. Without rebalancing, your portfolio can slowly become riskier or more conservative than you intended, which may not match your goals, timeline, or comfort with volatility.

In this guide you will learn why rebalancing is important, the main approaches (time-based vs. threshold-based), practical step-by-step instructions, real-world examples, tax and cost considerations, common mistakes to avoid, and quick FAQs for beginners.

Why Rebalancing Matters

Asset classes (stocks, bonds, cash, etc.) rarely move in sync. Over time, higher-return assets like stocks usually grow faster and can take up a bigger share of your portfolio. That increases your exposure to stock market swings beyond your plan.

Rebalancing restores your intended risk profile. If your original allocation is designed to match your time horizon and risk tolerance, maintaining it helps you avoid unintentionally taking on more or less risk than you planned.

Beyond risk control, rebalancing enforces a disciplined investment habit: buying low and selling high. When stocks outperform, rebalancing typically sells some winners and buys lagging assets, which is the opposite of emotional chasing.

When to Rebalance

There are two common methods for deciding when to rebalance: time-based schedules and threshold-based triggers. Each has pros and cons and can be combined.

Time-based rebalancing

Time-based rebalancing uses a fixed schedule, monthly, quarterly, semiannually, or annually. It’s easy to automate and simple to follow.

Pros: predictable, low mental overhead, works well with automatic contributions. Cons: may trade too often after small market moves, or miss material drift between check-ins.

Threshold-based rebalancing

Threshold-based rebalancing acts when an allocation deviates by a set amount, for example, rebalancing whenever any allocation moves 5% away from target. This focuses activity on meaningful drift.

Pros: likely fewer trades than frequent time-based schedules, trades only when meaningful imbalance exists. Cons: requires regular monitoring and may trigger during volatile periods.

Practical hybrid approach

Many investors use a hybrid rule: check periodically (e.g., quarterly) but only rebalance if allocations exceed thresholds (e.g., 5% or 10%). This balances discipline and efficiency.

Example guideline: review quarterly and rebalance if any asset class deviates by more than 5% from target; otherwise wait until the annual review.

How to Rebalance: Step-by-Step

Rebalancing can be simple if you follow a repeatable process. Below is a practical workflow you can adopt immediately.

1. Measure your current allocation. Add up the market values of each asset class across accounts to calculate percentages.
2. Compare to your target allocation. Identify which asset classes are overweight or underweight.
3. Choose a rebalancing method. Decide whether to use cash flows, trades, or both to rebalance.
4. Execute trades or redirect contributions. Use contributions to buy underweight assets first to minimize selling winners.
5. Factor in costs and taxes. Prioritize tax-efficient moves inside taxable accounts and do most selling within tax-advantaged accounts.
6. Document and schedule the next review. Keep records of reason and method for future consistency.

Using new contributions and dividends

A low-cost way to rebalance is to direct new contributions, dividend reinvestments, and cash inflows toward underweight asset classes. This minimizes trading and potential tax events.

Example: if stocks are overweight, divert new contributions to bonds until allocations are back in line.

Trading, sell vs. buy decisions

If you must trade, you can either sell overweight assets and buy underweight assets or adjust by only buying underweights. Selling realizes gains and may create tax liabilities in taxable accounts.

As a rule, use selling inside tax-advantaged accounts (IRAs, 401(k)s) when possible, and prefer buying inside taxable accounts to avoid capital gains events.

Practical Examples (Numbers and Tickers)

Example 1, Simple 60/40 portfolio: Start with $60,000 in stocks and $40,000 in bonds (60%/40%). After a strong year, stocks gain 30% and bonds gain 5%.

Calculation: Stocks become $78,000; bonds become $42,000. Total portfolio = $120,000. New allocation: stocks 65% ($78k/$120k), bonds 35%. To rebalance back to 60/40, sell $6,000 of stocks and buy $6,000 of bonds.

Example 2, Using ETFs: Suppose you hold $VOO (U.S. stocks) and $BND (U.S. bonds). If $VOO outperforms $BND, direct new contributions to $BND until you return to target allocation. If trading, sell $VOO inside a tax-deferred account to avoid immediate capital gains.

Example 3, Individual stocks vs. broad funds: If $AAPL and $MSFT have large gains pushing individual stock exposure above your target, consider trimming those positions to buy broader funds like $VOO. Trimming concentrated positions reduces single-company risk.

Tax and Cost Considerations

Taxes are a major reason to plan how and where you rebalance. Selling appreciated assets in taxable accounts creates capital gains taxes. Long-term vs. short-term holding periods matter for rates.

Use tax-advantaged accounts (IRAs, 401(k)s) to do most of the selling. In taxable accounts, prefer rebalancing via new contributions or tax-loss harvesting opportunities if available.

Also consider trading costs and bid-ask spreads. Many brokerage platforms offer commission-free trading on common ETFs and stocks, which reduces the cost of rebalancing. Still, limit small frequent trades that add up over time.

Common Mistakes to Avoid

• Ignoring taxes: Selling winners in taxable accounts without consideration for capital gains can reduce net returns. Avoid this by planning trades in tax-advantaged accounts or using contributions.
• Rebalancing too often or too rarely: Excessive rebalancing increases costs; infrequent rebalancing lets drift worsen portfolio risk. Use a clear rule and stick to it.
• Letting emotions drive choices: Chasing winners or panicking during downturns can derail strategy. Follow your predetermined rebalancing rule to stay disciplined.
• Overlooking fees and slippage: Small accounts can be disproportionately impacted by trading fees. Check your platform’s costs and prefer ETFs with tight spreads.
• Ignoring account location: Treat taxable and tax-advantaged accounts differently when deciding where to trade or reallocate assets.

FAQ

Q: How often should a beginner rebalance their portfolio?

A: A simple approach is to review quarterly and rebalance annually, or review quarterly and rebalance only if allocations drift by 5% or more. This hybrid method balances simplicity with responsiveness.

Q: Will rebalancing lower my returns?

A: Rebalancing can reduce portfolio volatility and sometimes slightly lower raw returns while improving risk-adjusted returns. It enforces selling winners and buying laggards, which may underperform during long trends but helps maintain intended risk.

Q: Can I rebalance automatically?

A: Yes. Many brokerages and robo-advisors offer automatic rebalancing options. Automated rebalancing applies your chosen schedule or threshold across accounts, which reduces effort and emotional bias.

Q: Should I rebalance during a market crash?

A: Stick to your rules. During crashes, rebalancing may mean buying risk assets at lower prices, which can be beneficial over the long term. Avoid making ad-hoc changes based on panic; use your planned rebalancing method.

Bottom Line

Rebalancing is a straightforward but powerful tool to keep your portfolio aligned with your goals and risk tolerance. Whether you use a time-based schedule, threshold triggers, or a hybrid approach, the priority is having a clear, repeatable plan.

Actionable next steps: define your target allocation, choose a rebalancing rule (e.g., quarterly with a 5% threshold), and decide how you will execute (use new contributions, automatic rebalancing tools, or manual trades with tax-aware placement). Track results and review your plan annually.

Consistent, disciplined rebalancing reduces emotional decision-making and helps maintain the balance between risk and reward that suits your investment objectives.