Once you’ve chosen an asset allocation, markets will gradually pull your portfolio away from it. Whatever has grown fastest takes up a bigger share, and your risk level drifts with it. Rebalancing is the routine of bringing your mix back to target.
An example
Suppose your target is 60% stocks and 40% bonds, and you start with $6,000 in stocks and $4,000 in bonds. Over a year, stocks rise 20% and bonds stay flat.
- Stocks are now worth $7,200 and bonds $4,000, for a total of $11,200.
- Stocks have drifted to about 64% of the portfolio.
- To get back to 60/40 you’d hold $6,720 in stocks and $4,480 in bonds: sell $480 of stocks and buy $480 of bonds.
Rebalancing quietly enforces a disciplined habit: trimming what has risen and adding to what has lagged.
How often to rebalance
- On a schedule: once or twice a year is common and easy to remember.
- By threshold: rebalance when an asset class drifts more than a set amount from its target, for example five percentage points.
- Either way: rebalancing too often adds cost and effort for little benefit.
Ways to rebalance
- Direct new money: put new contributions into whatever is underweight. No selling required.
- Sell and buy: move money from overweight assets to underweight ones.
- Use tax-advantaged accounts first: selling in a taxable account can trigger capital gains tax, so many investors rebalance inside retirement accounts where possible.
- Let a fund do it: target-date and balanced funds rebalance automatically.
Key takeaway
Rebalancing keeps your risk where you chose to put it. Pick a simple rule, apply it calmly, and don’t let it become an excuse to trade often.
This guide is for education only and isn’t personal financial advice. Investing involves risk, including the possible loss of money you invest. Example figures are illustrations, not predictions.