Rebalancing
Getting your investment mix back on track
Category: Investment Strategy
Difficulty: Beginner
Definition
Buying and selling investments to get back to your target allocation. Like tuning up your car to keep it running smoothly.
Why Rebalancing Matters
The Problem
Your investment mix changes over time: - Stocks do well â stock portion gets bigger - Bonds do poorly â bond portion gets smaller
- Your 60/40 portfolio becomes 70/30 - Youâre taking more risk than you planned
The Solution
Rebalancing fixes the drift: - Sell some of whatâs done well (stocks) - Buy more of whatâs done poorly (bonds) - Get back to your 60/40 target - Maintain your intended risk level
Simple Example
Your target: 60% stocks, 40% bonds
After one year: - Stocks grew 20% - Bonds stayed flat - New allocation: 67% stocks, 33% bonds
Rebalancing action: - Sell some stocks - Buy more bonds
- Result: Back to 60% stocks, 40% bonds
When to Rebalance
Calendar-Based (Most Common)
Set schedule approach: - Once per year: Simple, low cost - Every 6 months: More control - Quarterly: For active managers
Pros: Easy to remember, not too frequent Cons: Might miss big market moves
Threshold-Based
Rebalance when allocation drifts too far: - Example: Rebalance when any asset class is 5% off target - 60% stock target becomes 55% or 65% â time to rebalance - More responsive to market volatility
Pros: Responds to actual changes Cons: Might rebalance too often in volatile markets
Smart Rebalancing Tips
Use new money first: - Getting a bonus? Put it in whateverâs underweight - Monthly investment? Direct to underweight assets - Reduces need to sell anything
Tax considerations: - Rebalance in retirement accounts first (no taxes) - Be careful about capital gains in taxable accounts - Consider tax-loss harvesting opportunities
How to Rebalance
Step 1: Check Your Current Allocation
Calculate what you actually own: - Add up all your stock investments - Add up all your bond investments
- Calculate percentages of total portfolio - Compare to your target allocation
Step 2: Decide What to Change
Figure out whatâs off target: - Whatâs overweight? (sell some) - Whatâs underweight? (buy more) - How much do you need to move?
Step 3: Make the Trades
Rebalance efficiently: - Start with new money if available - Use tax-advantaged accounts when possible - Donât worry about being perfect - Small deviations are okay
Rebalancing Strategies
The 5% Rule
Simple threshold approach: - Rebalance when any asset class is 5% off target - Example: 60% stock target â rebalance if it hits 55% or 65% - Balances maintenance with transaction costs
Annual Rebalancing
Once-per-year approach: - Pick a date (like your birthday or January 1st) - Check allocations and rebalance if needed - Simple and low-maintenance - Good for most investors
Quarterly Check-ins
Every three months: - More frequent monitoring - Catch bigger moves before they get extreme - Good compromise between maintenance and costs
Rebalancing Benefits
Enforces Discipline
Forces you to do the right thing: - Sell high: Take profits from winners - Buy low: Add to underperformers
- Stay disciplined: Removes emotion from decisions - Maintain strategy: Stick to your long-term plan
May Improve Returns
Not guaranteed, but possible: - Captures volatility through systematic trading - Benefits from mean reversion in markets - Maintains optimal risk-return balance - Compounds small advantages over time
Common Rebalancing Mistakes
Over-Rebalancing
Too much of a good thing: - Rebalancing every month or week - Trying to maintain perfect allocations - High transaction costs eat up benefits - Creating unnecessary tax events
Under-Rebalancing
Letting things drift too far: - Ignoring allocations for years - Letting winners become too large - Taking more risk than intended - Missing rebalancing opportunities
Emotional Rebalancing
Making changes based on feelings: - Rebalancing because markets are scary - Changing allocations instead of true rebalancing - Market timing disguised as rebalancing - Abandoning strategy during volatility
Tools for Rebalancing
Target Date Funds
Automatic rebalancing: - Fund company does it for you - No work required on your part - Professional management - Perfect for hands-off investors
Robo-Advisors
Algorithm-based rebalancing: - Automatic threshold-based rebalancing - Tax-loss harvesting included - Low fees (usually 0.25-0.5%) - Good for busy people
Do-It-Yourself
Manual rebalancing: - You decide when and how to rebalance - Complete control over the process - Lowest fees if you use low-cost brokers - Requires discipline and knowledge
The Bottom Line
Rebalancing is like regular maintenance for your portfolio. It keeps your investment plan on track and forces good investment behavior.
Key principles: 1. Set a schedule and stick to it 2. Donât overthink it - close enough is good enough 3. Use new money to rebalance when possible 4. Stay disciplined - sell high, buy low
Most experts recommend rebalancing once or twice per year for most investors.