Portfolio Rebalancing
Definition
The process of periodically buying and selling investments to restore your portfolio to its target asset allocation, maintaining your intended risk level as market prices change.
Portfolio rebalancing brings your allocation back to target after market movements drift it away. If your target is 70% stocks / 30% bonds and a stock market rally pushes you to 80/20, rebalancing involves selling stocks and buying bonds to return to 70/30. This disciplined approach forces you to sell high and buy low.
Without rebalancing, your portfolio's risk profile gradually changes. After a prolonged bull market, a 70/30 portfolio might become 85/15 — significantly more aggressive than intended. If you're near retirement and depending on that 30% bond allocation for stability, the unnoticed drift could expose you to devastating losses in a downturn.
Common rebalancing approaches: calendar-based (rebalance quarterly or annually), threshold-based (rebalance when any asset class drifts more than 5% from target), and hybrid (check quarterly, rebalance if thresholds are exceeded). Research suggests that rebalancing frequency matters less than having any rebalancing discipline at all.
Tax-efficient rebalancing minimizes the tax cost. In tax-advantaged accounts (401k, IRA), rebalancing has no tax consequences. In taxable accounts, selling appreciated assets triggers capital gains. Strategies to reduce tax impact include: rebalancing with new contributions (direct new money to underweight asset classes), rebalancing in tax-advantaged accounts first, and harvesting losses during rebalancing.
The emotional challenge of rebalancing is selling your best-performing investments and buying underperformers. This feels counterintuitive — why sell winners? Because reversion to the mean is powerful, and maintaining your target allocation prevents any single asset class from dominating your risk profile.
Where this appears in Clarity
Clarity automatically tracks and calculates these concepts across your connected accounts.
Related Terms
Frequently Asked Questions
How often should I rebalance?
Annual rebalancing is sufficient for most investors. More frequent rebalancing (quarterly) provides tighter alignment but more transactions and potential tax events. Threshold-based rebalancing (when allocations drift 5%+ from target) provides a good balance between precision and simplicity.
Does rebalancing improve returns?
Rebalancing primarily manages risk, not returns. In some market conditions it improves returns (buying low, selling high), in others it slightly reduces them (trimming winners early). The primary benefit is maintaining your intended risk level and preventing dangerous concentration in a single asset class.