A portfolio that starts the year at 60% stocks and 40% bonds rarely ends it that way. Markets move unevenly, and the asset class that performs best gradually takes up a larger share of the total. Rebalancing is the process of bringing a portfolio back to its intended mix. It is a simple idea, but the questions of when, how and in which accounts can make it feel more complicated than it is.
This article is informational, not financial advice.
What Rebalancing Means
Rebalancing means adjusting holdings so that the portfolio’s allocation returns to its target. According to Investor.gov, the investor education site run by the U.S. Securities and Exchange Commission, investments grow at different rates, so a portfolio can drift from its target and take on more or less risk than intended. The site uses an example in which a 60% stock target rises to 80% after market gains.
In that example, the portfolio is now considerably more exposed to stock market declines than its owner originally planned. Rebalancing means trimming the assets that have grown and adding to those that have lagged. Investor.gov notes that this can feel counterintuitive, since it involves reducing what has done well, but that it may help investors sell high and buy low.
Why Drift Matters
An allocation is usually chosen to match a time horizon and a tolerance for losses. Drift changes that match without any deliberate decision. A household that wanted moderate risk can end up with an aggressive portfolio simply because stocks have had a strong run. The reverse can also happen after a market decline, leaving a portfolio more conservative than its owner intended.
Rebalancing is therefore a risk-management step more than a return-seeking one. The goal is to keep the portfolio consistent with the plan, not to predict which asset class will do well next.
Three Common Approaches
| Approach | How it works | Trade-off |
|---|---|---|
| Calendar-based | Review and adjust at set intervals, such as every six or 12 months | Simple and predictable, but may miss large moves between dates |
| Threshold-based | Adjust when an asset class moves beyond a preset percentage from its target | Responds to actual drift, but requires monitoring |
| Cash-flow-based | Direct new contributions or withdrawals toward underweight assets | Can avoid selling, but works best when cash flows are large relative to the portfolio |
Investor.gov describes the first two: some experts suggest rebalancing at regular intervals such as every six or 12 months, while others suggest doing so when an asset class moves beyond a preset percentage from its target. Either way, the site says rebalancing tends to work best when done relatively infrequently. The cash-flow approach is a widely used variation rather than something specific to that source.
Practical Ways to Rebalance
- Redirect new contributions. Payroll deferrals and regular deposits can be pointed at the underweight asset class, which may reduce the need to sell anything.
- Reinvest dividends and interest selectively. Instead of automatic reinvestment in the same holdings, payouts can be directed where the portfolio is light.
- Sell and buy within tax-advantaged accounts. Adjustments inside retirement accounts generally do not create a current tax bill in the way trades in a regular brokerage account can.
- Use a fund that does it automatically. Investor.gov notes that with target date funds, the fund’s investment adviser handles rebalancing, typically shifting toward a more conservative mix as the target date approaches.
Costs and Taxes to Consider
Rebalancing is not free of friction. Trading in a taxable account can realize capital gains, and some investments carry transaction costs or other fees. These considerations are one reason infrequent rebalancing is often favored over constant tinkering.
The specific tax treatment depends on the account type, how long assets were held and the investor’s tax situation, so details are best confirmed with a tax professional or official IRS guidance. This article does not attempt to cover those rules.
An Illustrative Example
Consider a hypothetical investor with a 60/40 target. After a strong market for stocks, the mix has moved to 70/30. The investor has several choices:
- Sell some stock funds and buy bond funds until the mix returns to 60/40.
- Send the next several months of contributions entirely to bonds until the mix is closer to target.
- Accept a wider band, such as allowing a few percentage points of drift before acting, and do nothing yet.
None of these is universally correct. The right choice depends on the size of the drift, the account types involved, and how disciplined the investor wants the process to be. The numbers here are hypothetical and are included only to illustrate the mechanics.
Common Pitfalls
Rebalancing too often. Frequent adjustments can add costs and taxes without meaningfully improving the portfolio’s risk profile.
Never rebalancing. The opposite problem is leaving a portfolio untouched for years and discovering that its risk level has changed substantially.
Ignoring the whole picture. Many households hold investments across several accounts, such as a workplace plan, an IRA and a brokerage account. Looking at each in isolation can hide the overall allocation. Reviewing the combined mix is often more informative.
Rebalancing on emotion. Selling the winner can feel uncomfortable, and buying the laggard can feel worse. A written rule, whether calendar-based or threshold-based, reduces the temptation to decide in the moment.
Treating the target as permanent. A target allocation is a reflection of goals and time horizon. When those change, the target may need to change as well.
Building a Simple Routine
- Write down the target allocation and the reason for it.
- Choose a method: a fixed review date, a threshold, or both.
- Check the combined allocation across all accounts at each review.
- Prefer using new money and tax-advantaged accounts before selling in taxable accounts.
- Record what was changed and when, so the next review starts from a clear baseline.
The Bottom Line
Rebalancing keeps a portfolio aligned with the risk level its owner chose. The mechanics are straightforward: compare the current mix with the target, then trim what has grown and add to what has lagged. Whether a household uses a calendar, a threshold, new contributions or a target date fund, a consistent and relatively infrequent routine is the common thread in the guidance from investor education sources.
This article is informational, not financial advice. Individual circumstances, costs and tax treatment vary; consider consulting a qualified professional.
Sources: Investor.gov (U.S. Securities and Exchange Commission), “Asset Allocation.”
