Rebalancing

Rebalancing is bringing a portfolio back to its target asset allocation after some holdings have grown faster than others, by selling overweight categories, buying underweight ones or directing new money to them.

How it works

The SEC's beginners' guide to asset allocation defines rebalancing as bringing your portfolio back to your original asset allocation mix, explaining that over time some investments grow faster than others and holdings can fall out of alignment with investment goals. By rebalancing, the guide says, you ensure the portfolio does not overemphasize one or more asset categories and return it to a comfortable level of risk. Its example is a target of 60% stocks that has drifted to 80% after a market rise: the investor either sells some stock or buys underweighted categories to restore 60%. The guide lists three ways to rebalance: sell from overweight categories and buy underweight ones, purchase new investments only in underweight categories, or direct ongoing contributions toward underweight categories until the target is restored.

Hypothetical example: a 60/40 portfolio drifts to $78,000 stocks and $42,000 bonds; restoring the target means selling $6,000 of stocks and buying bonds. See asset allocation.

When to rebalance

FINRA's asset allocation page says there is no official timeline that determines when you should rebalance and suggests considering it once a year as part of an annual review. The two common approaches are calendar rebalancing, on a fixed date, and threshold rebalancing, whenever a category drifts more than a set number of percentage points from target; many investors combine them by checking on a schedule and acting only if the drift exceeds the threshold. Rebalancing has costs: selling appreciated holdings in a taxable account can realize capital gains, and trades may incur commissions or bid-ask spreads, which is why directing new contributions to underweight categories is often the cheapest method. The SEC guide stresses that rebalancing responds to market-driven drift; the target itself should change only with horizon, tolerance or goal.

Hypothetical example: stocks instead fall to $48,000 with bonds at $40,000; restoring 60/40 means buying about $4,800 of stocks, the opposite of the instinct to sell after a decline.