Portfolio Rebalancing: Maintaining Your Investment Strategy

You set a target allocation—60% stocks, 40% bonds. A year later, your portfolio is 70% stocks. What now? Portfolio rebalancing is the systematic process of realigning your investments with your goals. It's one of the most underrated wealth-building practices.

What Is Rebalancing?

The Problem Without Rebalancing:

• Winners grow larger and larger
• Portfolio becomes increasingly risky
• You're fully exposed when the crash comes

Example:

Without rebalancing, you're now taking 25% more stock risk than you intended.

Why Rebalancing Works

1. Risk Control

Keeps your portfolio aligned with your risk tolerance:

• Prevents drift toward excessive risk
• Maintains the diversification you designed
• Protects against "creeping" concentration

2. Forced Discipline

Removes emotion from investing:

• Systematically sells high (winners)
• Systematically buys low (laggards)
• No decision paralysis or market timing

3. Improved Risk-Adjusted Returns

Research shows rebalancing often improves returns:

• Not always higher absolute returns
• Better return per unit of risk
• Smoother wealth accumulation path

When to Rebalance

Time-Based Rebalancing

Rebalance on a set schedule:

Recommendation: Annually is sufficient for most investors. Pick a date (birthday, New Year) and stick to it.

Threshold-Based Rebalancing

Rebalance when allocation drifts beyond a threshold:

Example: Rebalance when any asset class is 5+ percentage points off target.

Pros:

• Only rebalances when needed
• Can reduce transaction costs
• Responds to major market moves

Hybrid Approach (Recommended)

Check allocation periodically (quarterly), but only rebalance if off by 5%+:

• Reduces unnecessary trading
• Still captures major drift
• Tax-efficient

How to Rebalance: Step by Step

Step 1: Know Your Target Allocation

Write it down:

• 60% stocks / 40% bonds
• Or more detailed: 45% U.S. stocks, 15% international, 40% bonds

Step 2: Calculate Current Allocation

Sum all accounts (401k, IRA, Roth, taxable):

• Don't rebalance each account separately
• View your entire portfolio as one allocation

Example:

Current: 83% stocks, 17% bonds Target: 60% stocks, 40% bonds Significantly overweight stocks

Step 3: Calculate Required Changes

To reach 60/40:

• Target stocks: $60,000
• Target bonds: $40,000
• Sell $23,000 of stocks, buy $23,000 of bonds

Step 4: Execute Efficiently

Choose the most tax-efficient method (see below).

Tax-Efficient Rebalancing Strategies

Strategy 1: Direct New Contributions (Best)

Direct new money to underweight assets:

• 401(k) contributions go to bonds
• No selling required
• No tax consequences

Works when:

• You're still saving
• Contribution amounts are meaningful relative to portfolio
• Drift isn't extreme

Strategy 2: Rebalance in Tax-Advantaged Accounts

Sell and buy within 401(k), IRA, or Roth:

• No immediate tax consequences
• Can make large changes freely
• Most common method

Strategy 3: Tax-Loss Harvesting in Taxable

When rebalancing taxable accounts:

• Sell losers to realize losses
• Use losses to offset gains
• Replace with similar (not identical) investments

Strategy 4: Asset Location Adjustment

Move assets between accounts during rebalancing:

• Keep bonds in 401(k)/IRA (tax-inefficient)
• Keep stocks in Roth (tax-free growth)
• Keep tax-efficient index funds in taxable

Rebalancing Across Multiple Accounts

View your allocation across ALL accounts:

Correct Approach:

The individual accounts look "unbalanced" but the total portfolio is close to target.

Incorrect Approach: Trying to make each account individually match your target.

Common Rebalancing Mistakes

Rebalancing During Market Extremes

Rebalancing feels hardest when it matters most:

During Crashes:

• Stocks have dropped 30%
• Your allocation is now 45% stocks (target: 60%)
• Rebalancing means buying MORE stocks
• This feels terrifying—but it's exactly right

During Bubbles:

• Stocks have soared
• Your allocation is now 80% stocks (target: 60%)
• Rebalancing means selling stocks
• This feels like leaving money on the table—but it's exactly right

Rebalancing Bands: Setting Your Triggers

Determine your rebalancing thresholds:

Tight Bands (±3%):

• More frequent rebalancing
• Higher costs and taxes
• Closer to target at all times

Wide Bands (±10%):

• Less frequent rebalancing
• Lower costs and taxes
• More drift from target

Moderate Bands (±5%): Recommended

• Good balance of control and efficiency
• Rebalance annually OR when 5%+ off target

The Glide Path: Rebalancing Over Time

Your target allocation should change as you age:

Each year, rebalance toward your age-appropriate target.

Target-Date Fund Alternative

Target-date funds rebalance automatically:

• Manage allocation over time
• Gradually become more conservative
• Fully hands-off approach
• Slightly higher fees

Rebalancing Checklist

The Math of Rebalancing

Without Rebalancing (Drift Portfolio):

• Bull market: More and more stocks (higher risk)
• Bear market: Devastated by overexposure
• Emotions often lead to selling at the bottom

With Rebalancing:

• Systematically sell winners (take profits)
• Systematically buy losers (add at discount)
• Maintain intended risk level through cycles

Research Finding: Rebalanced portfolios often have lower returns in bull markets but dramatically better returns in full market cycles (bull + bear). They also have significantly lower volatility.

Rebalancing and Behavior

The hardest part of rebalancing is psychological:

• Selling winners feels like throwing away money
• Buying losers feels like catching falling knives
• Both are exactly what you should do

The solution: Automate or systematize

• Set calendar reminders
• Follow a checklist
• Don't check performance before rebalancing
• Execute mechanically

Advanced: Rebalancing in Retirement

In retirement, rebalancing changes:

Sequence of Withdrawals:

1. Withdraw from overweight asset first
2. Combine rebalancing with distributions
3. Reduces separate transactions

Bucket Strategy:

• Bucket 1: 1-2 years expenses in cash
• Bucket 2: 3-7 years in bonds
• Bucket 3: 7+ years in stocks
• Rebalance by refilling buckets

The Bottom Line

Rebalancing is boring, mechanical, and essential. It removes emotion from investing, controls risk, and systematically buys low and sells high. Set your target allocation, check it annually (or when markets move dramatically), and adjust in tax-advantaged accounts when you're off by 5%+. It's one of the few investment practices that's simple, proven, and free.