Portfolio rebalancing is one of the most important yet overlooked investment practices. While choosing the right assets is essential, maintaining the right balance over time is just as critical. As markets move, your portfolio naturally drifts away from its original allocation, often increasing risk without you realizing it.
This guide explains what portfolio rebalancing is, why it matters, and how to do it correctly to protect and grow your investments.
What Is Portfolio Rebalancing?
Portfolio rebalancing is the process of realigning your investments to match your target asset allocation. Over time, some assets outperform others. As a result, your portfolio may become more heavily weighted toward riskier or less diversified positions.
Rebalancing restores balance by selling assets that have grown too large and buying those that have fallen below their target allocation.
Why Rebalancing Your Portfolio Is Important
1. Controls Risk
As stocks rise faster than bonds or cash, your portfolio becomes riskier. Rebalancing reduces excessive exposure to any single asset class.
2. Maintains Your Investment Strategy
Your original allocation reflects your goals, time horizon, and risk tolerance. Rebalancing keeps your portfolio aligned with that plan.
3. Encourages Disciplined Investing
Rebalancing forces you to buy low and sell high. This disciplined approach removes emotional decision-making.
4. Improves Long-Term Stability
Although rebalancing does not guarantee higher returns, it helps smooth volatility and protect capital during market downturns.
When Should You Rebalance Your Portfolio?
There is no single correct schedule, but most investors follow one of these approaches:
1. Time-Based Rebalancing
This method involves reviewing your portfolio at regular intervals:
- Annually
- Semi-annually
- Quarterly (for more active investors)
Annual rebalancing is sufficient for most long-term investors.
2. Threshold-Based Rebalancing
Instead of a calendar, you rebalance when an asset class deviates by a certain percentage—typically 5% to 10%—from its target allocation.
This method responds more directly to market movements.
3. Life-Event Rebalancing
Major life changes such as retirement, marriage, job changes, or having children may require rebalancing to reflect new financial goals or risk tolerance.
How to Rebalance Your Portfolio Step by Step
Step 1: Review Your Target Allocation
Confirm your ideal mix of assets. For example:
- 60% stocks
- 30% bonds
- 10% alternatives
This allocation should align with your age, income stability, and investment horizon.
Step 2: Analyze Current Allocation
Compare your actual holdings to your target percentages. Identify which assets are overweight or underweight.
Step 3: Decide How to Rebalance
You can rebalance by:
- Selling overweight assets
- Buying underweight assets
- Redirecting new contributions
Using new contributions often minimizes taxes and transaction costs.
Step 4: Consider Tax Implications
Whenever possible, rebalance inside tax-advantaged accounts. In taxable accounts, be mindful of capital gains taxes.
Step 5: Execute and Monitor
Once rebalanced, continue monitoring your portfolio to ensure it stays aligned with your strategy.
Common Rebalancing Mistakes to Avoid
- Rebalancing too frequently
- Ignoring transaction fees
- Forgetting tax consequences
- Making emotional decisions
- Changing strategy based on market noise
Consistency matters more than precision.
Rebalancing for Different Investor Types
Long-Term Investors
Annual or threshold-based rebalancing works best. Focus on maintaining risk control.
Income-Focused Investors
Rebalancing helps maintain income stability by preventing overexposure to volatile assets.
Near-Retirees
More frequent reviews may be needed to protect capital and reduce volatility.
How Rebalancing Supports Long-Term Success
Over decades, small allocation drifts can significantly change portfolio risk. Rebalancing prevents unintended risk buildup and supports steady progress toward financial goals.
Additionally, disciplined rebalancing improves investor confidence and reduces panic during market downturns.
FAQ: Portfolio Rebalancing
1. Does rebalancing increase returns?
Not necessarily. Its main purpose is risk control and strategy alignment.
2. How often should beginners rebalance?
Once per year is usually sufficient.
3. Should I rebalance during market crashes?
Yes, if your allocation deviates significantly. This often means buying undervalued assets.
4. Can robo-advisors rebalance automatically?
Yes. Many robo-advisors offer automatic rebalancing.
5. Is rebalancing necessary for small portfolios?
Yes. Even small portfolios benefit from maintaining proper allocation.