When you set up your investments, you probably chose a mix of stocks, bonds and other assets that fit your goals, timeline and comfort with risk. But as markets move, that mix drifts. Over time, your portfolio can end up riskier or more conservative than you intended. Rebalancing is the process of bringing it back in line with your target.
What asset allocation means
Your asset allocation is how your investments are divided among different types of assets, such as stocks, bonds and cash. Asset allocation is one of the most important investment decisions you’ll make, because it largely determines your portfolio’s potential returns and how much it might fluctuate.
Stocks have historically offered higher long-term returns but with more volatility. Bonds have generally been less volatile, providing stability and income. Your ideal mix depends on factors like how long until you need the money, your financial goals and how comfortable you are with market ups and downs.
Why your mix drifts
Different investments grow at different rates. Suppose you want 70% stocks and 30% bonds. If stocks rise sharply while bonds stay flat, you might end up with 80% stocks and 20% bonds. Your portfolio is now riskier than you planned, meaning a market decline could hit harder than you expected.
If stocks fall significantly, the opposite happens. You might end up with 60% stocks and 40% bonds, giving you less growth potential than you want for your long-term goals.
Without rebalancing, your portfolio’s risk level can drift far from your original plan over time, often becoming more concentrated in whatever has performed best recently.
How rebalancing works
Rebalancing means selling some of what has grown above your target and buying what has fallen below it. In the example above, you would sell some stocks and buy bonds to return to 70% stocks and 30% bonds.
Rebalancing is a disciplined way to sell high and buy low. It systematically trims investments that have risen in value and adds to those that have fallen, which runs counter to the emotional temptation to chase recent winners.
Rather than selling, you can also rebalance by directing new money, such as regular contributions, to the parts of your portfolio that are below target. This approach can reduce or eliminate the need to sell, which helps avoid taxes and trading costs.
How often to rebalance
There are several common approaches to deciding when to rebalance.
The calendar approach means rebalancing on a set schedule, such as once a year or every six months, regardless of how much your portfolio has drifted. It’s simple and easy to remember. Many people choose a meaningful date, such as the start of the year or their birthday.
The threshold approach means rebalancing when an investment drifts a certain amount from its target, such as 5 percentage points. If your target is 70% stocks, you would rebalance if stocks rise above 75% or fall below 65%. This approach responds to actual market movements rather than the calendar.
A combination approach means checking your portfolio on a schedule, such as quarterly or annually, but only rebalancing if drift is significant. This balances discipline with avoiding unnecessary trades.
Research suggests that there’s no single perfect rebalancing frequency. Rebalancing too often can increase costs and taxes without much benefit, while rarely rebalancing can let risk drift too far. For most individual investors, rebalancing once a year or when drift exceeds a set threshold is reasonable.
Ways to limit taxes and costs
Rebalance inside tax-advantaged accounts when possible. Trades within IRAs, 401(k)s and other tax-advantaged accounts generally don’t trigger taxes, so you can rebalance freely within them.
Use new contributions or dividends to buy underweight investments. Directing new money to the parts of your portfolio below target can rebalance without selling.
In taxable accounts, be mindful of capital gains taxes when selling investments that have increased in value. Selling investments held more than a year generally results in lower long-term capital gains rates. Some investors use losses in other investments to offset gains.
Avoid frequent trading, which can increase costs and taxes. Check whether your broker charges fees for trades or fund purchases.
Let funds do it for you
If rebalancing sounds like a chore, there are ways to automate it. Target-date funds automatically maintain a mix of stocks and bonds and rebalance regularly, gradually becoming more conservative as the target date approaches. Balanced funds and some other asset allocation funds also rebalance automatically to maintain a set mix.
Some brokers and robo-advisors offer automatic rebalancing for your account, adjusting your portfolio when it drifts from your target.
Review your target allocation too
Rebalancing keeps you aligned with your target, but your target itself may need to change over time. As you get closer to retirement or other goals, or as your circumstances and risk tolerance change, you may want to adjust your target allocation, often becoming more conservative as you approach the time you’ll need the money.
This article is for education only and isn’t investment advice.
Content on The Evergreen Edit is for educational and informational purposes only and is not individualized financial, investment, tax or legal advice. Learn more.
This article is for educational purposes only and isn't personalized financial, tax or legal advice. Consider talking with a qualified professional about your situation.
Kiara Miller — Founder & Editor
Kiara Miller is the founder and editor of The Evergreen Edit. He has been doing independent finance research for two decades and reviews every article before it's published.
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