How to Rebalance Your Portfolio: When, Why, and How Often

You set up a 70/30 stock/bond portfolio. Stocks have a great year. A year later, you're at 82/18 without doing anything. Your portfolio has drifted — you're now taking more risk than you intended. Rebalancing fixes that.

Most people either rebalance too often (creating unnecessary tax events) or never (ending up with allocations they didn't choose). The right answer is somewhere in the middle.

How Drift Happens

When stocks outperform bonds, your equity percentage grows automatically. When stocks underperform, your bond percentage grows.

Example: $100,000 portfolio, target 70/30.

• Year 1 start: $70,000 stocks, $30,000 bonds
• Stocks return 20%, bonds return 4%
• Year 1 end: $84,000 stocks, $31,200 bonds = $115,200 total
• New allocation: 72.9% stocks, 27.1% bonds
• After 3 good stock years, you might be at 82/18 without noticing

The allocation drift isn't catastrophic at 70→73%. But if you started at 60/40 and drifted to 75/25 approaching retirement, that's a meaningful change in risk.

How to Rebalance

Method 1: Sell overweight, buy underweight Sell enough of what's grown to bring it back to target, use proceeds to buy what's lagged.

Downside: In taxable accounts, selling triggers capital gains taxes.

Method 2: Direct new contributions Instead of selling anything, direct all new contributions (monthly investments, dividends) into the underweight asset class. Works slowly but generates no tax.

Best method for most investors: use new contributions to rebalance; only sell if drift is extreme (10%+ from target) and you're in a tax-advantaged account.

Method 3: Tax-advantaged only Do all your rebalancing inside your 401(k) or IRA, where there are no capital gains taxes. Leave your taxable account alone. Use contributions to rebalance the taxable side.

How Often to Rebalance

Calendar rebalancing: Check once per year and rebalance if needed. Threshold rebalancing: Rebalance whenever an asset class drifts more than 5% from target.

Research from Vanguard suggests annual or threshold rebalancing produce similar outcomes. Quarterly or monthly rebalancing adds transaction costs with minimal benefit.

My preference: check annually, rebalance only if drift exceeds 5% from target. Most years you won't need to do anything.

The Tax Cost of Rebalancing

In taxable accounts, every rebalancing sale potentially triggers capital gains tax. This is why:

1. Do most rebalancing inside 401(k)/IRA first
2. Use new contributions to rebalance taxable accounts when possible
3. When you must sell in taxable, look for losses to offset against (tax-loss harvesting)

Does Rebalancing Improve Returns?

Not necessarily — and this surprises people.

Rebalancing actually tends to reduce long-term returns slightly in trending bull markets (you're continuously trimming your winners). What it does is reduce risk and volatility — keeping you from accidentally becoming 90% stocks by 60.

The real benefit: behavioral. A portfolio that stays close to your intended allocation is one you're less likely to panic-sell during a crash, because the risk level matches what you signed up for.

The Bottom Line

• Drift happens naturally; stocks growing faster than bonds means you're slowly taking more risk
• Rebalance annually or when drift exceeds 5% from target
• Prioritize rebalancing inside tax-advantaged accounts (no capital gains)
• Use new contributions to rebalance taxable accounts before selling anything
• Rebalancing is about managing risk and behavior, not maximizing returns

Use our Retirement Calculator to see how different allocations affect your projected balance at retirement.