Portfolio Rebalancing: When and How to Rebalance Your Investments
You set up your investment portfolio with a target allocation — say, 80% stocks and 20% bonds. A year later, stocks have rallied and now make up 90% of your portfolio. Should you rebalance back to 80/20? How often should you do this? And is over-rebalancing a mistake?
This guide covers everything you need to know about portfolio rebalancing.
What Is Rebalancing?
Portfolio rebalancing is the process of buying or selling investments to bring your portfolio back to your target asset allocation.
Your target allocation reflects your risk tolerance and time horizon. A 30-year-old saving for retirement might target 90% stocks / 10% bonds. A 60-year-old nearing retirement might target 50% stocks / 50% bonds.
Markets don't stay put. When stocks rise significantly, they become a larger percentage of your portfolio than you intended. When stocks fall, bonds (which often hold steadier) become a larger percentage. Rebalancing restores your original risk profile.
Example:
You start with $100,000: $80,000 in a total stock market fund and $20,000 in a bond fund (80/20 split).
After a strong year, stocks grew to $100,000 and bonds stayed at $20,000. Your portfolio is now $120,000, but the allocation has drifted to 83/17 — you're taking more risk than intended.
To rebalance to 80/20: you need $96,000 in stocks and $24,000 in bonds. Sell $4,000 of stocks and buy $4,000 of bonds.
Why Bother Rebalancing?
1. It maintains your target risk level.
If you set an 80/20 allocation because that felt right for your situation, drifting to 90/10 means you're taking more risk than you planned. In a bear market, you'll feel the losses more than you expected.
2. It enforces "buy low, sell high."
Rebalancing systematically makes you sell the assets that have performed well (selling high) and buy the assets that have lagged (buying low). This is good discipline that most investors struggle to follow emotionally.
3. It's low-maintenance by design.
A good rebalancing strategy takes minimal time and doesn't require predicting what the market will do next.
How Often Should You Rebalance?
There are two main approaches:
Calendar-based rebalancing — Rebalance on a fixed schedule: annually, semi-annually, or quarterly. Most research suggests annual rebalancing is optimal for most investors. More frequent rebalancing (monthly, quarterly) increases trading costs and tax drag without significantly improving outcomes.
Threshold-based rebalancing — Rebalance when any asset class drifts more than a set percentage from its target. A common threshold is 5-10%. If your target is 80/20 and stocks drift to 85% or 75%, rebalance. Otherwise, leave it alone.
Hybrid approach — Check once per year and only rebalance if your allocation has drifted by more than 5%. This minimizes unnecessary trades while ensuring you don't drift too far.
For most investors, annual rebalancing with a 5% threshold is the sweet spot. It keeps transaction costs low while maintaining reasonable control over your risk level.
Methods to Rebalance
Method 1: Sell high performers, buy laggards
The direct approach: sell the asset that's above its target and use the proceeds to buy the asset that's below its target.
Pros: Simple, works in any account Cons: In taxable accounts, selling triggers capital gains taxes
Method 2: Direct new contributions
Instead of selling, direct all new contributions to the underweighted asset class until you're back in balance.
Example: Your stocks grew to 87% but your target is 80%. Stop adding to stocks and put all new 401(k) contributions into the bond fund until you're back at 80/20.
Pros: No selling = no taxes, no transaction costs Cons: Works best when you're making regular contributions; may take a while to rebalance if the drift is large
Method 3: Reinvest dividends into underweighted assets
If your account allows dividend reinvestment choice, direct dividends to the underweighted asset class rather than the fund that paid them.
Pros: Gradual, automatic, low-cost Cons: Dividends alone may not be enough to fully rebalance large drifts
Best Practice
In tax-advantaged accounts (401(k), IRA): Sell and buy directly — there's no tax consequence, so the direct method is fastest and simplest.
In taxable brokerage accounts: Prefer directing new contributions and reinvested dividends to underweighted assets. Use direct sales only when necessary, and consider the tax impact (preferring to sell assets held over one year for long-term capital gains rates).
Rebalancing in a 401(k)
Most 401(k) providers offer automatic rebalancing — a setting that rebalances your portfolio back to your target allocation on a fixed schedule (typically quarterly or annually).
If your 401(k) offers this, turn it on. It removes the need to think about it.
Check under "Portfolio Settings," "Investment Elections," or "Auto-Rebalance" in your 401(k) provider's website.
Common Rebalancing Mistakes
Over-rebalancing. Rebalancing too frequently (monthly, or whenever the market moves 1-2%) generates unnecessary trades, taxes, and transaction costs. Stick to annual rebalancing or a 5% threshold — don't react to normal market noise.
Ignoring taxes in taxable accounts. Selling assets in a taxable account triggers capital gains taxes. Use new contributions and dividends to rebalance in taxable accounts first; resort to selling only when necessary.
Rebalancing separately instead of holistically. If you have multiple accounts (401(k), Roth IRA, taxable), consider your overall allocation across all accounts, not each account independently. You might hold all bonds in your tax-advantaged accounts and all stocks in your taxable account, rebalancing at the portfolio level.
Chasing performance instead of rebalancing. Rebalancing is the opposite of chasing performance. Don't change your target allocation based on which asset class has recently done well.
Do You Even Need to Rebalance?
If you use a target-date fund or a robo-advisor, rebalancing is done for you automatically. In that case, no action needed.
If you use a single total-market index fund, there's nothing to rebalance — the fund itself holds a diversified mix.
Rebalancing only matters if you hold a multi-asset portfolio you manage yourself.
A Simple Annual Rebalancing Checklist
- Once per year (same date — January 1st works well), open your brokerage accounts.
- Check current allocation across all accounts combined.
- If any asset class has drifted more than 5% from target: rebalance.
- In tax-advantaged accounts: sell and buy directly.
- In taxable accounts: direct future contributions to underweighted assets; sell only if needed.
- Update your calendar reminder for next year.
That's it. 30 minutes per year.
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