You set up your investment portfolio with a specific allocation: 70% stocks, 30% bonds. That was three years ago. Stocks have performed well—your allocation is now 78% stocks, 22% bonds. You’re not sure if this matters, when to fix it, or how to rebalance without triggering taxes or fees.
Portfolio rebalancing keeps your investments aligned with your risk tolerance and goals. It’s not complicated, but it needs to be done right. Here’s your practical guide.
Why Rebalancing Matters
Your portfolio doesn’t stay balanced automatically:
The drift problem:
Different assets grow at different rates. Stocks typically outpace bonds, so a 60/40 stock/bond portfolio gradually becomes 70/30, then 75/25, eventually 80/20. You’re taking more risk than you intended, potentially with your retirement money.
The behavioral benefit:
Rebalancing forces you to sell high and buy low—the opposite of emotional investing. When stocks surge and bonds lag, rebalancing means selling some winners and buying underperformers. This contrarian action is psychologically difficult but mathematically sound.
Risk management:
Your original allocation reflected your risk tolerance. Letting it drift means taking on more (or sometimes less) risk than appropriate for your situation. Regular rebalancing maintains your intended risk level.
When to Rebalance
You don’t need to rebalance constantly. Choose one approach:
Calendar-based rebalancing:
Rebalance once yearly on a specific date—January 1st, your birthday, tax day. Simple, automatic, requires minimal monitoring. Research shows annual rebalancing captures most benefits with minimal effort.
Threshold-based rebalancing:
Rebalance when any asset class drifts 5-10% from target. If your target is 60% stocks and it reaches 65-70%, rebalance. This captures large movements while avoiding overtrading. Requires quarterly monitoring.
Combination approach:
Check quarterly, rebalance if any asset is 5%+ off target. If nothing triggers the threshold, rebalance annually anyway. This balances responsiveness with restraint.
For most investors: Annual calendar-based rebalancing is sufficient. Pick a date, set a calendar reminder, do it every year.
How to Actually Rebalance
The mechanics are straightforward:
Step 1: Calculate current allocation
List your total portfolio value and each asset class value. Calculate percentages. If you have $100,000 total with $72,000 in stocks and $28,000 in bonds, you’re at 72/28.
Step 2: Compare to target
If your target is 70/30 and you’re at 72/28, you’re 2% over on stocks and 2% under on bonds. With $100,000 portfolio, that’s $2,000 to rebalance.
Step 3: Execute the trades
Sell $2,000 of stock funds, buy $2,000 of bond funds. Your allocation returns to 70/30.
Tax-Efficient Rebalancing Strategies
Rebalancing in taxable accounts can trigger capital gains taxes. Minimize this:
Rebalance with new contributions:
Instead of selling overweighted assets, direct new money to underweighted assets. This gradually brings your portfolio back to target without selling anything. Works well if you’re regularly contributing.
Prioritize tax-advantaged accounts:
If you have both 401(k)/IRA and taxable brokerage accounts, rebalance within retirement accounts first. No tax consequences there. Only rebalance taxable accounts when absolutely necessary.
Tax-loss harvest while rebalancing:
If holdings are down, sell those first to realize losses (which offset gains elsewhere). Then buy back similar but not identical funds to maintain allocation. Example: sell one S&P 500 fund at a loss, buy a different S&P 500 fund.
Accept approximate rebalancing:
Getting to exactly 70/30 isn’t necessary. Reaching 69/31 or 71/29 is close enough. Don’t trigger significant taxes to achieve perfect precision.
Asset Location Strategy
Where you hold different assets matters for tax efficiency:
Tax-advantaged accounts (401k, IRA):
Hold bonds and actively managed funds here. These generate ordinary income and frequent capital gains, which are tax-inefficient. In retirement accounts, taxes are deferred or eliminated.
Taxable brokerage accounts:
Hold index funds and ETFs. These rarely distribute capital gains and dividends are taxed favorably. You also get access to tax-loss harvesting opportunities.
This placement strategy reduces overall tax drag on your portfolio while maintaining your desired allocation.
When NOT to Rebalance
Rebalancing isn’t always appropriate:
During major life changes:
If you’re about to retire, getting married, having a baby, or facing other significant life events, pause rebalancing until you reassess your overall allocation. Your target might need to change.
When it triggers significant taxes:
If rebalancing would create a massive tax bill (thousands of dollars), wait. Either rebalance with new contributions over time or accept being slightly off-target. The tax cost might exceed the rebalancing benefit.
When the drift is minimal:
If your 70/30 portfolio is now 71/29, don’t bother. The benefit of rebalancing 1-2% is negligible. Save the transaction costs and effort for when drift is meaningful (5%+).
Adjusting Your Target Allocation Over Time
Your target allocation should evolve with age and circumstances:
The age-in-bonds rule:
A simple guideline: bond percentage equals your age. At 30, hold 30% bonds. At 60, hold 60% bonds. This gradually reduces risk as you near retirement. Adjust every 5-10 years, not annually.
Major milestone adjustments:
- 10 years from retirement: Shift 5-10% from stocks to bonds
- At retirement: Continue gradual shift toward bonds
- After retirement: Many experts recommend 40-50% stocks to maintain growth
Don’t change your target allocation based on market conditions. That’s market timing, not rebalancing. Change it based on life circumstances, not market movements.
Automatic Rebalancing Options
Many platforms offer automatic rebalancing:
Target-date funds:
Automatically rebalance and adjust allocation as you age. Zero effort required. Ideal for hands-off investors.
Robo-advisors:
Betterment, Wealthfront, and similar services automatically rebalance your portfolio and tax-loss harvest. Charge 0.25-0.50% annually. Convenient but adds cost.
Brokerage features:
Some brokerages offer automatic rebalancing features for free. Vanguard, Fidelity, and Schwab allow you to set target allocations and automatically rebalance on your chosen schedule.
The Bottom Line
Rebalancing isn’t complicated: check your allocation annually, see if you’ve drifted significantly from target, and adjust if needed. This simple maintenance keeps your investment strategy aligned with your goals and risk tolerance.
The hardest part is actually doing it consistently. Set a specific annual date. Add it to your calendar with a reminder. When that date arrives, spend 30 minutes reviewing and rebalancing if necessary. Then don’t think about it until next year.
Pick your rebalancing date today—January 1st, your birthday, tax day, or any meaningful date. Set the calendar reminder. When it arrives next year, you’ll know exactly what to do. Simple, effective, and far less stressful than constantly monitoring your portfolio.
