What Is Portfolio Rebalancing?
Rebalancing is the process of periodically buying and selling assets within a portfolio to restore its original target asset allocation, which naturally drifts over time as different asset classes grow at different rates. For example, if stocks significantly outperform bonds over a period, a portfolio’s stock allocation will gradually creep above its original target percentage, unintentionally increasing the portfolio’s overall risk level beyond what was originally intended.
Why Portfolios Drift Over Time
Because different asset classes rarely move in perfect lockstep, a portfolio’s actual composition will naturally diverge from its target allocation as time passes. A strong multi-year bull market in stocks, for instance, can cause a portfolio originally set at 60% stocks and 40% bonds to drift toward 70% stocks or higher, exposing the investor to more risk than their original plan called for.
Common Rebalancing Approaches
Calendar-Based Rebalancing
This approach involves rebalancing on a fixed schedule — such as annually or semi-annually — regardless of how far the portfolio has actually drifted, offering simplicity and predictability at the cost of potentially missing significant drift that occurs between scheduled dates.
Threshold-Based Rebalancing
This approach triggers a rebalance whenever an asset class drifts beyond a predetermined percentage point threshold (such as 5 percentage points) from its target, allowing the portfolio to respond more dynamically to market conditions rather than following a fixed calendar.
| Method | Trigger | Trade-off |
|---|---|---|
| Calendar-Based | Fixed schedule (e.g., annually) | Simple, but may miss interim drift |
| Threshold-Based | Allocation deviates by set amount | Responsive, but requires more monitoring |
Frequently Asked Questions
Does rebalancing guarantee better returns?
Not necessarily in every period — rebalancing is primarily a risk management discipline that keeps a portfolio aligned with its intended risk level, rather than a strategy specifically designed to maximize returns in every market environment.
Are there tax implications to rebalancing?
Yes, selling appreciated assets in a taxable account to rebalance can trigger capital gains taxes, which is why many investors prefer to rebalance within tax-advantaged retirement accounts when possible, or use new contributions to shift allocation without selling.
Can I rebalance without selling any assets?
Yes, directing new contributions toward the underweighted asset class is a common tax-efficient way to gradually rebalance a portfolio over time without needing to sell existing appreciated holdings.
How often do most financial advisors recommend rebalancing?
Many advisors suggest reviewing a portfolio’s allocation at least annually, though the specific frequency can depend on the investor’s account type, market volatility, and personal preference for a hands-on or hands-off approach.
Key Takeaways
Rebalancing restores a portfolio’s original target allocation after market movements cause it to drift, helping maintain an investor’s intended risk level over time. Common approaches include calendar-based and threshold-based methods, each with distinct trade-offs in simplicity versus responsiveness. This article is for informational purposes only and does not constitute investment advice.
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