Over time, your investment portfolio naturally drifts away from its original plan as different assets grow at different rates. This drift can unintentionally increase your risk or shift your allocation in ways that don’t match your goals. Portfolio rebalancing fixes that by adjusting your holdings back to your target mix. In this guide, you’ll learn what rebalancing is, why it matters, and how often you should do it to stay on track.
What Is Portfolio Rebalancing?
Portfolio rebalancing is the process of bringing your investments back to your original allocation. For example, if your target is a 60% stocks and 40% bonds portfolio, strong stock market growth might push that to 70/30. Rebalancing involves selling some of the overweighted assets, stocks in this case, and buying more of the underweighted ones to restore your 60/40 balance. The goal is not to chase performance, but to maintain a consistent risk level.
Why Rebalancing Matters
Rebalancing helps you manage risk by preventing your portfolio from becoming too aggressive or too conservative. If stocks surge, your portfolio may carry more risk than you intended; if bonds grow, you might miss out on growth opportunities. Rebalancing also helps lock in gains by selling assets that have appreciated and reinvesting into areas that need strengthening. Most importantly, it encourages disciplined investing rather than reacting emotionally to short-term market movement.
When Should You Rebalance?
There isn’t a perfect universal schedule, but there are three common approaches. Time-based rebalancing means adjusting your portfolio on a set schedule, every six or twelve months, for example. Threshold-based rebalancing involves making changes only when an allocation drifts by a certain percentage, such as 5–10% away from your target. Finally, life-event rebalancing adjusts your portfolio when major financial changes occur, like a new job, marriage, inheritance, or nearing retirement. All three methods work, what matters is choosing one you’ll stick to.
How to Rebalance Your Portfolio
Rebalancing typically involves selling some of the investments that have grown faster than others and using the proceeds to buy assets that have lagged. If you prefer not to sell, you can also use new contributions to build up the underweighted areas over time. It’s important to pay attention to fees and taxes, especially when rebalancing in taxable accounts. Many investors handle this inside tax-advantaged accounts like IRAs or 401(k)s to avoid capital gains taxes on trades.
Tips for Rebalancing Efficiently
To rebalance efficiently, look for opportunities within tax-advantaged accounts, where you can make adjustments without triggering taxes. Avoid adjusting your portfolio too frequently, over-rebalancing can increase costs without improving long-term performance. You can also choose automated investment platforms or certain ETFs that handle rebalancing for you, making the entire process more hands-off.
Summary
Rebalancing is a simple yet powerful tool that helps keep your portfolio aligned with your goals and risk tolerance. By adjusting your investments back to their target allocation, you maintain control, avoid unnecessary risk, and strengthen long-term performance. Whether you rebalance on a schedule or based on thresholds, consistency is the key to keeping your portfolio healthy and focused on the future.
FAQs
How often should I rebalance my portfolio?
Most investors rebalance once or twice a year, or whenever their allocation drifts more than 5–10% from their target. Consistency matters more than timing.
Does rebalancing hurt returns?
Not necessarily. While it may slightly reduce returns during bull markets, it helps manage risk and prevents large losses when markets decline, improving long-term stability.
Is rebalancing the same as timing the market?
No. Rebalancing is about maintaining your risk level, not predicting market moves. You’re restoring balance, not trying to buy low or sell high.
Should I rebalance in a taxable account?
You can, but be mindful of capital gains taxes. Many investors prefer to rebalance inside retirement accounts like 401(k)s or IRAs to avoid tax consequences.
What’s better, selling investments or using new contributions to rebalance?
If possible, use new contributions to add to underweighted areas. This avoids unnecessary selling, reduces taxes, and keeps your strategy efficient.
Can I automate rebalancing?
Yes. Many robo-advisors and some ETFs automatically rebalance for you, keeping your portfolio aligned without manual intervention.
What happens if I never rebalance?
Your portfolio can drift too far from your original plan, usually becoming riskier as stocks grow faster than bonds. Over time, that imbalance can increase volatility and potential losses.