How to Rebalance Your Investment Portfolio
Portfolio rebalancing is the one maintenance task every investor needs. Here's what it is, when to do it, and how to do it without triggering unnecessary taxes.
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When you first invest, you set a target allocation — maybe 80% stocks and 20% bonds, or 70% US stocks and 30% international. Over time, as different assets grow at different rates, that allocation drifts. Stocks might grow to 90% of your portfolio, leaving you more exposed to market swings than you intended.
Rebalancing is the process of bringing your portfolio back to its original target. It is one of the most important — and most neglected — maintenance tasks in investing.
Why Rebalance?
There are two main reasons:
Risk management. If stocks have surged and now represent 90% of your portfolio when you targeted 70%, you are taking more risk than you planned. A market correction will hurt you more than it should.
Forced buy-low, sell-high. Rebalancing means selling assets that have risen (selling high) and buying assets that have fallen (buying low). Over long periods, this mechanical discipline adds meaningful returns.
When to Rebalance
There are two common approaches:
Calendar rebalancing: Rebalance on a fixed schedule — once a year is the most common recommendation. Set a date (your birthday, January 1st, whatever is memorable) and review your allocation annually.
Threshold rebalancing: Rebalance whenever any asset class drifts more than 5% from its target. So if your target is 70% stocks and they grow to 75%, you rebalance. This is more precise but requires monitoring.
For most investors, annual rebalancing is sufficient. More frequent rebalancing increases transaction costs without meaningfully improving results.
How to Rebalance
Step 1: Check your current allocation. Log in to your brokerage and calculate what percentage of your portfolio each asset class represents today.
Step 2: Compare to your target. If you are 5% or more off target, it is time to rebalance.
Step 3: Choose your rebalancing method.
- Sell and buy: Sell the overweight asset and buy the underweight asset. Simple, but may trigger capital gains taxes in taxable accounts.
- Direct new contributions: Instead of selling, direct new investments into the underweight asset until you reach your target. No tax implications. Best for accounts where you are still contributing regularly.
- Rebalance in tax-advantaged accounts first: Rebalance inside your 401k or IRA — no tax consequences for selling and rebalancing there. Avoid rebalancing in taxable accounts if possible.
Tax Considerations
In a taxable brokerage account, selling an overweight asset triggers capital gains taxes. Short-term gains (assets held less than one year) are taxed as ordinary income. Long-term gains (held over one year) are taxed at 0%, 15%, or 20% depending on income.
Strategies to minimise tax drag: rebalance primarily in tax-advantaged accounts (401k, IRA), use new contributions to rebalance in taxable accounts, and only sell in taxable accounts if the drift is significant enough to justify the tax cost.
Rebalancing in Practice: A Simple Example
You target 70% VTI (US stocks), 20% VXUS (international), 10% BND (bonds). After a strong year for US stocks, your actual allocation is 78% / 17% / 5%.
You have two options: sell some VTI and buy VXUS and BND, or direct your next 6 months of contributions entirely into VXUS and BND until you are back on target. The second option avoids taxes completely.
The Bottom Line
Rebalancing is not exciting. Done well, it is almost invisible. But over a 30-year investment horizon, investors who rebalance consistently end up with portfolios that better match their risk tolerance — and often better returns — than those who let their allocations drift unchecked.
Set a calendar reminder. Check once a year. Adjust if needed. That is all it takes.
The Bogleheads' Guide to Investing by Taylor Larimore et al. — Has an excellent, practical section on asset allocation and rebalancing. The no-nonsense approach that millions of investors rely on.
The Little Book of Common Sense Investing by John C. Bogle — Covers why simplicity and discipline — the foundations of good rebalancing — beat complexity every time.
Prefer audiobooks? Both titles are available on Audible — try it free for 30 days and get your first audiobook included.
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