Table of Contents
As markets fluctuate, your investment portfolio can drift away from your original strategy. Some assets may outperform, while others underperform, leading to an imbalanced allocation that no longer reflects your risk tolerance or financial goals.
Rebalancing is the process that keeps your investment portfolio on course. It’s not about chasing returns but restoring balance, maintaining discipline, and managing risk effectively. This blog will show you how to rebalance your investment portfolio like a pro, using simple steps and innovative strategies.
How to Rebalance Your Investment Portfolio Like a Pro: What Is It?
Portfolio rebalancing is the process of realigning the weight of assets in your investment portfolio back to your original or desired allocation. Over time, as markets fluctuate, your portfolio’s asset mix (e.g., 60% stocks, 40% bonds) can drift, potentially exposing you to more risk than intended or reducing your potential returns.
For example, if stocks perform well and grow to 70% of your portfolio, while bonds shrink to 30%, your portfolio becomes more aggressive than planned. Rebalancing involves selling a portion of the overperforming asset (stocks) and buying more of the underperforming one (bonds) to return to your target allocation.
Rebalancing helps:
- Maintain your risk tolerance.
- Lock in gains by selling high and buying low.
- Stay aligned with long-term financial goals.
It can be done manually, automatically (with robo-advisors or employer retirement plans), or with new contributions and dividend reinvestments. Most investors rebalance on a set schedule (e.g., annually or semi-annually) or when an asset allocation deviates beyond a set threshold (e.g., ±5–10%).
When Should You Rebalance Your Portfolio?
Time-Based Rebalancing
This approach uses a fixed schedule—rebalancing your portfolio every quarter, six months, or annually. It’s simple and easy to follow, making it ideal for passive investors.
Threshold-Based Rebalancing
This method involves monitoring your asset allocation and rebalancing only when a specific threshold is breached, commonly 5% or 10% deviation from the target.
Example: If your target is 60% stocks and your current allocation hits 65% or higher, it’s time to rebalance.
Hybrid Approach
Combine time-based and threshold-based strategies for greater flexibility and control. Review your portfolio regularly and act when time and deviation align.
Step-by-Step Guide to Rebalancing Your Investment Portfolio
Step 1: Define Your Target Asset Allocation
Before rebalancing, establish your ideal portfolio mix, such as 70% stocks, 25% bonds, and 5% cash. This mix should reflect your:
- Risk tolerance.
- Investment goals (growth, income, preservation).
- Time horizon (short-term vs. long-term).
Step 2: Review Your Current Allocation
Log in to your brokerage or investment account and check how your current assets are distributed. Compare each asset class’s current weight with your target. If any allocation has drifted significantly (e.g., more than 5–10%), it’s time to rebalance.
Step 3: Identify the Imbalances
Pinpoint which asset classes are overweight or underweight. For example:
- If stocks grew from 70% to 78%, they’re overweight.
- If bonds fell from 25% to 18%, they’re underweight.
This helps you decide what to sell and what to buy.
Step 4: Choose a Rebalancing Method
There are two common approaches:
1. Sell and Buy: Sell assets above target and use the proceeds to buy assets below target.
2. Use New Contributions: Direct new deposits or dividends into underweight assets instead of selling. This avoids taxes and transaction costs.
Step 5: Execute the Rebalance
Make the necessary trades in your account:
- If you’re using a taxable account, be mindful of capital gains.
- In tax-advantaged accounts (IRAs, 401(k)s), you can rebalance freely without triggering taxes.
Some brokerages offer automated rebalancing tools—consider using them if available.
Step 6: Consider Costs and Taxes
Before making trades:
- Check for trading fees or commissions.
- Understand tax implications if you’re selling appreciated assets.
Rebalancing too frequently in taxable accounts can reduce net returns due to taxes.
Step 7: Set a Rebalancing Schedule
Decide how often you’ll rebalance:
- Time-based: Annually, semi-annually, or quarterly
- Threshold-based: When an asset class drifts ±5%–10% from the target.
You can also combine both strategies for more control.
Step 8: Monitor and Adjust
Rebalancing isn’t a one-time event. Your target allocation should evolve as your financial goals, age, or risk tolerance change. Revisit your plan annually or after major life changes.
Tax and Cost Considerations During Rebalancing
Rebalancing helps maintain your desired asset allocation, but if not handled carefully, it can trigger costs that reduce your net returns. Understanding the tax and transaction implications is essential, especially when managing investments in taxable brokerage accounts.
1. Capital Gains Taxes
You may owe capital gains tax when you sell an asset that has appreciated in value. This applies only to taxable accounts (not IRAs or 401(k)s).
- Short-Term Gains: Profits from assets held for less than a year are taxed at your ordinary income rate, typically higher.
- Long-Term Gains: Assets held longer than a year are taxed at reduced capital gains rates (0%, 15%, or 20%, depending on income).
Tip: To reduce tax impact, prioritize selling assets with minimal gains or losses. If your broker supports it, you can also consider selling “specific lot” items.
2. Tax-Loss Harvesting
If rebalancing involves selling assets at a loss, you may use that loss to offset capital gains or deduct up to $3,000 in losses against regular income each year.
This strategy—called tax-loss harvesting—can soften the tax blow of rebalancing and improve after-tax returns. Just be cautious of the wash-sale rule, which disallows a loss if you buy the same or “substantially identical” security within 30 days before or after the sale.
3. Use Tax-Advantaged Accounts for Rebalancing
If possible, do most rebalancing within:
Trades inside these accounts are not subject to capital gains tax, allowing you to rebalance freely without tax consequences. To make rebalancing more flexible, consider shifting your most active or volatile holdings into tax-sheltered accounts.
4. Minimize Trading Costs
Some brokers charge commissions for trades, especially for mutual funds or less common ETFs. Rebalancing too often may rack up unnecessary fees.
How to avoid this:
- Use commission-free ETFs or funds offered by your broker.
- Limit rebalancing frequency to once or twice a year unless allocations drift significantly.
- Use dividend reinvestments and new contributions to rebalance gradually without selling.
5. Consider Turnover and Hidden Costs in Funds
When rebalancing between mutual funds or ETFs, consider their internal turnover and expense ratios:
- High-turnover funds may trigger distributions (and taxes) even if you don’t sell.
- Look for tax-efficient ETFs or index funds with low turnover.
6. Watch Out for Redemption Fees and Exit Loads
Some mutual funds charge redemption fees if sold within a specific time (30–90 days). Others have exit loads—fees paid when you sell. Always check the fund’s prospectus before rebalancing.
Rebalancing Strategies for Different Investor Types
1. Conservative Investors
Conservative investors focus on capital preservation and minimizing volatility. Their portfolios usually have a higher allocation to bonds, dividend-paying stocks, and other low-risk assets. For them, annual rebalancing is typically enough, unless the market causes a 5–10% deviation in their asset mix. The goal is to stay within a narrow risk band while ensuring income and stability.
2. Moderate Investors
Moderate investors aim to balance growth and risk. Their portfolios often contain a roughly even mix of stocks and bonds. A semi-annual rebalancing schedule works well for this group, helping them adjust to market shifts without reacting too frequently. If any asset class deviates by more than 10% from its target allocation, it’s a good time to rebalance.
3. Aggressive Investors
Aggressive investors prioritize long-term capital growth and are comfortable with higher market volatility. They tend to invest heavily in equities, including growth stocks or international markets. For them, quarterly rebalancing is effective. It helps them manage fast-changing portfolio values and redirect gains into higher-risk, higher-return areas like emerging markets or technology sectors.
4. Income-Focused Investors
Income investors prioritize generating reliable cash flow from their portfolios. They often hold dividend-paying stocks, REITs, and fixed-income securities. These investors should rebalance annually, especially as interest rates or income needs shift. Rebalancing helps maintain a consistent yield while adjusting for market conditions or lifestyle changes.
5. Hands-Off Investors
Investors who prefer a set-it-and-forget-it approach—such as those using robo-advisors or target-date funds—can rely on automatic rebalancing. These tools adjust the portfolio as needed without manual intervention. This strategy is ideal for long-term savers who want diversification and discipline without active involvement.
6. DIY or Active Investors
DIY investors like to stay closely involved with their portfolios and may rebalance more frequently, monthly, or whenever allocations shift by 5% or more. This strategy allows them to respond quickly to market trends and capitalize on short-term opportunities. However, avoiding emotional decisions or overtrading requires intense discipline, time, and awareness.
Conclusion
Portfolio rebalancing is one of the most potent tools in long-term investing. Regularly realigning your asset mix ensures your investment strategy stays true to your goals. The key is staying consistent, minimizing unnecessary costs, and focusing on your long-term vision. The process keeps your portfolio in check, your risks managed, and your wealth plan intact.
You can check out Beem, the personal finance app trusted by over 5 million Americans for any financial aid, from cash advances to help with budgeting and even tax calculations. In addition, Beem’s Everdraft™ lets you withdraw up to $1,000 instantly and with no checks. Download the app here.
FAQs About How to Rebalance Your Investment Portfolio Like a Pro
What happens if I never rebalance my portfolio?
If you skip rebalancing altogether, your portfolio can drift away from your original asset allocation. For instance, if stocks perform well, they may grow to dominate your holdings, making your portfolio riskier than intended. Over time, this can lead to increased volatility and exposure to market downturns. Rebalancing helps align your investment strategy with your goals and risk tolerance, offering stability as markets shift.
How often should I rebalance my portfolio?
Most investors rebalance either on a fixed schedule—like once or twice a year—or when their asset allocation drifts by more than 5–10% from target levels. The ideal frequency depends on your investment strategy, account size, and personal goals. Too frequent, and you risk incurring unnecessary fees and taxes; too infrequent, your portfolio may become overly aggressive or conservative without you realizing it.
Does rebalancing guarantee better returns?
Rebalancing isn’t meant to maximize returns but to manage risk. While it may occasionally boost performance by encouraging a buy-low, sell-high discipline, its primary benefit is preserving your desired asset mix. By maintaining balance between stocks, bonds, and other assets, rebalancing reduces the chance of overexposure to one sector and helps smooth returns across market cycles.
Should I rebalance in a down market?
Down markets can be smart times to rebalance. When stocks fall, their share in your portfolio shrinks. Rebalancing often means buying more of those now-lower-priced assets while trimming others that held their value. This discipline forces you to buy low and sell high, countering emotional decision-making. However, you should also ensure you’re not drawing on cash you need in the short term.
Is it bad to rebalance too often?
Rebalancing too frequently can lead to excessive transaction costs, tax liabilities, and over-complication without significant benefit. For long-term investors, quarterly or semiannual rebalancing is often enough. Over-managing can reduce your net returns and create stress. Instead, focus on thresholds—rebalance only when allocations deviate meaningfully from your target, typically by 5–10%.
Can I automate rebalancing?
Many brokerages, retirement plans, and robo-advisors offer automatic rebalancing features. These services monitor your portfolio and make periodic adjustments to realign with your chosen allocation. This removes emotion and guesswork from the process while ensuring your investments align with your strategy. Automation is particularly helpful for busy investors who want a hands-off, disciplined approach.
Is rebalancing the same as market timing?
Not at all. Market timing involves predicting future movements—something even professional investors rarely do well. Rebalancing, on the other hand, is about maintaining a consistent strategy regardless of market fluctuations. You’re not guessing trends; you’re adjusting based on changes in allocation. It’s a long-term risk management practice, not a short-term bet on performance.
Should I rebalance my retirement portfolio differently?
The same rebalancing principles apply, but with greater emphasis on capital preservation as you near retirement. That means gradually shifting toward safer assets—like bonds or cash equivalents—to reduce volatility. Retirees often follow a “glide path” that lowers stock exposure over time. Rebalancing ensures this transition happens smoothly and prevents sudden overexposure to riskier assets late in your career.
What’s the easiest way to get started with rebalancing?
Start by identifying your ideal asset allocation—say 70% stocks and 30% bonds. Then review your portfolio to see how far your actual mix has drifted. If the difference exceeds 5–10%, sell overweight assets and buy those underweight to restore balance. Consider using tools or apps that track allocations or choose a robo-advisor that automates rebalancing for you.
