Investing isn’t always a “set it and forget it” activity. Even if you carefully choose the right mix of stocks, bonds, and other investments, your portfolio can gradually drift away from your original plan as markets rise and fall.
That’s where portfolio rebalancing comes in.
Rebalancing an investment portfolio means adjusting your investments periodically so they return to your desired asset allocation. It can help keep your portfolio aligned with your goals, timeline, and comfort with risk without trying to predict what the market will do next.
Here’s how portfolio rebalancing works, when you may want to do it, and some strategies for keeping your investments on track.
What Does It Mean to Rebalance an Investment Portfolio?
When you build an investment portfolio, you may decide how much money you want invested in different types of assets.
For example, you might choose:
- 70% stocks
- 25% bonds
- 5% cash or other investments
That mix is known as your asset allocation.
But those percentages won’t necessarily stay the same.
Suppose stocks have a particularly strong year. Your portfolio might eventually become 80% stocks, 17% bonds, and 3% cash.
You haven’t intentionally changed your investment strategy, but your portfolio has changed anyway.
Rebalancing means making adjustments to bring those percentages closer to your original targets.
Why Is Portfolio Rebalancing Important?
One of the biggest reasons to rebalance is risk management.
Imagine that you originally chose a portfolio containing 60% stocks because that was an appropriate amount of risk for your situation. After several years of strong stock market performance, stocks might make up 75% of your portfolio.
You now have considerably more exposure to stock market fluctuations than you originally intended.
The opposite can happen, too. After a major stock market decline, stocks may represent a smaller portion of your portfolio. If you leave things alone, your portfolio could become more conservative than you intended and potentially have less opportunity for long-term growth.
Rebalancing helps keep your investments consistent with the strategy you’ve chosen.
When Should You Rebalance Your Portfolio?
There’s no universal schedule that works for everyone. However, investors commonly use one of several approaches.
Rebalance on a Schedule
One of the simplest strategies is checking your portfolio at regular intervals.
You might review it:
- Once a year
- Every six months
- Every quarter
Checking doesn’t necessarily mean you need to make changes. You may discover that your investments are still reasonably close to your targets.
For many long-term investors, an annual portfolio review can be a simple way to keep tabs on asset allocation without constantly tinkering with investments.
Rebalance When Your Allocation Drifts
Another strategy is to rebalance only when an investment category moves a certain amount away from its target.
For instance, suppose your goal is to keep 60% of your portfolio in stocks. You could decide to rebalance whenever stocks fall below 55% or rise above 65%.
This is sometimes called threshold-based rebalancing.
Instead of making changes simply because a date appears on the calendar, you’re taking action when your portfolio has moved meaningfully away from your plan.
Combine the Two Strategies
You can also combine calendar and threshold rebalancing.
For example, you might review your portfolio every six months but only rebalance if one of your asset categories has drifted more than five percentage points from its target.
This can prevent unnecessary trading while still keeping your portfolio relatively close to your intended allocation.
How to Rebalance an Investment Portfolio
Rebalancing doesn’t have to be complicated.
Start by determining your desired asset allocation. Your ideal mix will depend on factors such as your age, financial goals, investment timeline, financial situation, and tolerance for market volatility.
Next, look at your current portfolio.
Suppose your target allocation is:
70% stocks / 30% bonds
But after a strong stock market run, your portfolio has become:
78% stocks / 22% bonds
To rebalance, you need to decrease your stock allocation and increase your bond allocation until you’re closer to your 70/30 target.
There are several ways to accomplish this.
Sell Investments That Are Overweight
The most obvious method is selling some of the investments that have grown beyond their target and using the proceeds to buy investments that are underweight.
In our example, you could sell some stocks and use the money to purchase bonds.
This method can quickly restore your target allocation, but there’s an important consideration: taxes.
Selling investments in a taxable brokerage account may result in capital gains taxes. Before selling, consider the potential tax consequences.
Trading inside tax-advantaged accounts such as IRAs and 401(k)s generally doesn’t create an immediate capital gains tax bill, although withdrawals and distributions may have their own tax consequences.
Rebalance With New Contributions
You don’t always have to sell investments to rebalance your portfolio.
Instead, consider directing new investment contributions toward whichever portion of your portfolio is underweight.
If stocks have grown to represent too much of your portfolio, for example, you could temporarily direct more of your new contributions toward bonds.
Over time, your allocation may move closer to your target without requiring you to sell appreciated investments.
This can be particularly useful when you’re regularly contributing to a workplace retirement plan or investment account.
Use Dividends and Interest
Dividends and interest payments can also help you rebalance.
Instead of automatically reinvesting dividends into the investment that generated them, you may be able to direct that money toward an underweight portion of your portfolio.
It may be a relatively small adjustment, but those dollars can add up over time.
Rebalance Across Multiple Accounts
Don’t forget to look at your investments as a whole.
You might have:
- A 401(k)
- Traditional or Roth IRA
- Taxable brokerage account
- Other investment accounts
You don’t necessarily need each individual account to have the exact same asset allocation.
Instead, you can consider your overall portfolio.
For example, you might hold more bonds in one retirement account while keeping more stock investments in another account. What matters is how all of your investments work together toward your overall target allocation.
Should You Rebalance When the Stock Market Crashes?
A significant market decline can cause your asset allocation to change quickly.
Suppose your target portfolio contains 70% stocks and 30% bonds. After a sharp stock market decline, stocks might suddenly represent only 60% of your portfolio.
Rebalancing could mean buying more stocks when prices have fallen.
That can feel uncomfortable, particularly when financial headlines are gloomy. But that’s part of the discipline behind rebalancing.
Rather than deciding what to buy based on fear or excitement, you’re following a predetermined investment strategy.
However, a market crash alone doesn’t necessarily mean you should immediately make changes. Check your portfolio against the rebalancing rules you’ve established first.
Rebalancing Can Encourage You to Buy Low and Sell High
One interesting side effect of rebalancing is that it can naturally encourage investors to trim assets that have performed particularly well and add money to assets that have lagged.
In other words, you may periodically sell high and buy lower without attempting to guess which investments will outperform next.
This doesn’t guarantee higher returns. Instead, it’s primarily a method of controlling risk and maintaining your chosen investment strategy.
Don’t Rebalance Too Often
Watching your investments every day can make relatively small market movements seem much more important than they actually are.
Frequent rebalancing may also result in additional trading costs, taxes, and unnecessary decisions.
It can also tempt you to react emotionally to market news.
For long-term investors, the goal generally isn’t to maintain a perfectly precise allocation every day. A portfolio that’s 61% stocks instead of exactly 60%, for example, probably doesn’t require immediate action.
Think of your target allocation as a range rather than something that needs to be perfect down to the decimal point.
When Should You Change Your Target Allocation?
Rebalancing and changing your investment strategy are two different things.
Rebalancing means returning your investments to your existing target allocation.
Changing your allocation means deciding that your target itself should be different.
You might consider changing your target allocation after a significant change in your circumstances, such as approaching retirement, changing your financial goals, needing money sooner than expected, or realizing that your current portfolio is more volatile than you’re comfortable with.
What generally isn’t a good reason to completely change your investment strategy is simply hearing predictions that the stock market is about to rise or fall.
Trying to time the market consistently is extremely difficult.
Target-Date Funds May Rebalance for You
If you don’t want to rebalance investments yourself, some investment products can handle much of the work automatically.
Target-date retirement funds, for example, typically maintain a diversified portfolio and periodically rebalance their holdings. They also generally become more conservative as the target retirement year approaches.
Robo-advisors and some managed investment accounts may offer automatic rebalancing as well.
Just remember that convenience doesn’t automatically make an investment appropriate for everyone. Check the investment’s fees, holdings, risk level, and strategy before investing.
A Simple Portfolio Rebalancing Example
Suppose you have a $100,000 portfolio with a target allocation of:
60% stocks: $60,000
40% bonds: $40,000
After stocks perform particularly well, your portfolio grows to $110,000:
Stocks: $72,000
Bonds: $38,000
Your new allocation is approximately 65% stocks and 35% bonds.
If you want to return to a 60/40 allocation, your new targets would be:
Stocks: $66,000
Bonds: $44,000
You could sell approximately $6,000 worth of stocks and purchase $6,000 of bonds.
Alternatively, you could direct future contributions toward bonds until the portfolio gradually moves closer to your desired allocation.
How Often Should You Check Your Investments?
There’s a difference between checking your account balance and reviewing your investment strategy.
You certainly can look at your investments whenever you’d like, but constantly reacting to daily market movements can make long-term investing harder than it needs to be.
Consider establishing a regular portfolio checkup, perhaps once or twice a year.
During your review, look at your current asset allocation, investment fees, diversification, financial goals, risk tolerance, and whether anything significant has changed in your life.
Then decide whether any adjustments are actually necessary.
The Bottom Line
Portfolio rebalancing isn’t about predicting the next stock market boom or crash. It’s about maintaining the investment strategy you’ve already decided is appropriate for you.
Over time, winning investments can become larger portions of your portfolio while underperforming assets shrink. Without occasional adjustments, you could gradually take on significantly more or less risk than you intended.
Whether you rebalance annually, use percentage thresholds, or rely on automatic rebalancing, having a plan can make investment decisions less dependent on emotion.
You don’t have to keep your portfolio perfectly balanced at all times. The goal is simply to keep your investments reasonably aligned with your financial goals, investment timeline, and tolerance for risk.
This article is for informational purposes only and should not be considered financial or investment advice. Investments involve risk, including the potential loss of principal. Consider your individual circumstances or consult a qualified financial professional before making investment decisions.
