Rebalancing Your Portfolio: Keeping Your Investments on Track

Portfolio rebalancing is a central practice for investors seeking to maintain discipline and manage risk over the long term. As markets fluctuate, the original asset mix can drift, exposing portfolios to unintended levels of volatility. By understanding the principles and methods of rebalancing, investors can ensure their holdings continue to reflect their objectives and risk tolerance.

What Is Portfolio Rebalancing?

Portfolio rebalancing is the systematic process of buying and selling assets to restore a predetermined allocation among asset classes. When markets move, some investments will outperform while others lag, causing the portfolio’s structure to shift from its intended targets.

For example, a portfolio originally set at a original mix of stocks and bonds—such as 60% equities and 40% fixed income—may drift to 70% equities and 30% bonds after a strong bull market. Rebalancing realigns the mix to reflect your strategic plan.

Why Rebalance Your Portfolio?

Restore your target risk profile. As certain assets grow faster than others, they can dominate the portfolio and increase overall risk. Rebalancing brings allocations back in line with your risk preferences and goals.

It also enforces selling appreciated assets and buying underperforming ones, promoting a disciplined “buy low, sell high” mindset that counters emotional, reactive decisions in volatile markets.

Although it does not guarantee superior returns, rebalancing can enhance smooth out returns over time by capturing gains in overvalued sectors and redeploying capital to undervalued areas.

Regular adjustments ensure investments remain aligned with evolving objectives, from retirement planning to saving for a major purchase, and allow investors to adapt to shifting market opportunities.

How to Rebalance

Investors can choose between time-based and threshold-based strategies:

• Time-based: review and reset allocations at fixed intervals, such as quarterly, semi-annually, or annually.
• Threshold-based: trigger rebalancing when an asset class deviates by a set percentage (e.g., 5%) from its target.

Consider a classic 60/40 equity/bond portfolio. If equities surge and push the ratio to 70/30, you would sell equities to buy bonds, embedding a disciplined “buy low, sell high” approach into your investment routine.

When executing trades, be mindful of costs and tax consequences. Using strategies to minimize unnecessary trading costs, such as threshold triggers or tax-advantaged accounts, can preserve more of your returns.

Diversification in Portfolio Construction

Effective rebalancing relies on having a well-diversified portfolio in the first place. Mixing equities, fixed income, real estate, cash, commodities, and alternative investments provides broad risk reduction across classes.

Within each asset category, further diversification by region, sector, industry, company size, and bond maturity can improve stability. Spreading investments across different economic cycles via spreading investments across regions and sectors helps cushion against localized downturns.

Alternative assets such as private equity, hedge funds, and collectibles may have low correlation with public markets but can carry higher fees and liquidity constraints. Geographic diversification protects against country-specific risks and captures global growth opportunities.

Empirical Evidence and Key Numbers

Research shows that portfolios can drift notably during market extremes. A balanced 50/50 equity/bond portfolio might shift to 56% equities and 44% bonds after a strong stock rally, resulting in an increased risk level beyond target.

The so-called “rebalancing bonus” arises because greater divergence between asset class returns amplifies the benefits of systematic realignment, delivering a greater impact on risk reduction and potential alpha over time.

Though the iconic 60/40 portfolio remains a widely used model, individual circumstances may call for adjustments across a spectrum from low to high risk:

When and How Often to Rebalance

There is no one-size-fits-all schedule. Many investors choose annual or semiannual reviews, while others prefer quarterly checks. A common rule of thumb is to rebalance when targets deviate significantly, often set at 5% bands around each allocation.

Frequent rebalancing reduces risk drift but may incur higher trading fees and tax liabilities. Striking the right balance between maintaining discipline and controlling costs is key to effective portfolio management.

Considerations and Challenges

Selling appreciated holdings in taxable accounts can result in capital gains taxes. It is crucial to realize capital gains tax liability when planning your rebalancing strategy.

Transaction costs vary across brokers and asset types. Using low-cost funds or commission-free platforms can help minimize impact on returns.

Personal factors—age, investment horizon, risk tolerance, and life events such as retirement or inheritance—should guide your target allocations and rebalancing cadence.

Expert Recommendations

• Use automated rebalancing features on your investment platform to remove emotion from allocation decisions.
• Consider target date funds that handle all rebalancing automatically as you approach specific retirement years.
• Combine a strategic asset allocation framework with tactical rebalancing to adapt to market shifts.

Professional guidance or robo-advisory services can further refine your approach and provide tailored support.

Key Takeaways for Readers

• Regular rebalancing is essential for maintaining risk discipline and aligning investments with goals.
• Each investor should adopt a personalized approach based on individual finances and objectives.
• Weigh the trade-offs between rebalancing frequency, transaction costs, and tax implications.

By embracing a systematic rebalancing strategy, you can navigate market volatility with confidence and keep your investments on a steady path toward your financial aspirations.