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Published: April 1, 2025
Want to protect your portfolio from hidden risks and market surprises? Managing your investments is like tending a garden: you plant the seeds, nurture growth, and occasionally trim back the overgrowth. That trimming—known as rebalancing—is the key to long-term financial success and peace of mind.
Over time, different investments grow at varying rates, causing your portfolio to drift away from its original plan. This shift can lead you to take on more risk—or less growth—than you initially intended. Knowing when and how to rebalance your portfolio can help maintain your desired risk level and maximize long-term returns.
Key Takeaways
- Portfolio drift occurs naturally as different investments perform at varying rates, shifting your intended asset allocation.
- Consider rebalancing when your allocation deviates significantly (often by 5% or more) or during major life events.
- Choose between schedule-based (fixed intervals) or threshold-based (percentage deviation) rebalancing methods, or combine both.
- Keep an eye on taxes and fees by rebalancing within tax-advantaged accounts and using cost-effective investment options.
Why Portfolio Drift Happens
At first, your investment strategy might start clearly balanced—say, 60% stocks for growth potential and 40% bonds for stability. But over time, stocks typically outperform bonds, causing the allocation to drift. Before you know it, your 60/40 portfolio could unintentionally shift to 75/25, significantly increasing your exposure to market fluctuations.
This drift can either leave you overly vulnerable in downturns or limit your growth potential if lower-performing assets dominate your portfolio. Recognizing this drift is critical to successful long-term investing.
Signs It’s Time to Rebalance
So, how can you tell when it’s time for rebalancing? There’s no one-size-fits-all answer, but common indicators include significant deviations from your original allocation or major life changes—such as retirement or financial milestones—that shift your risk tolerance.
Many experts recommend considering rebalancing when your portfolio deviates from its target allocation by more than 5%. It’s also a good practice to periodically review your portfolio annually or semi-annually, allowing you to spot potential issues before they become problematic.
Rebalancing: Schedule-Based vs. Threshold-Based
When deciding how to rebalance, investors typically choose between two main strategies: schedule-based and threshold-based.
Schedule-based rebalancing occurs at fixed intervals (quarterly, annually, etc.), making it easy to implement and maintain. However, it may lead you to rebalance even when the market hasn’t significantly altered your allocation, potentially incurring unnecessary costs or taxes.
Threshold-based rebalancing, by contrast, only happens when your portfolio allocation drifts beyond a predetermined percentage. This method is more responsive to actual market conditions but requires closer monitoring. Many investors find a hybrid approach—reviewing annually but rebalancing only if thresholds are crossed—effective for balancing simplicity with responsiveness.
Manual vs. Automated Rebalancing Tools
If you’re a DIY investor, manual rebalancing might appeal to your hands-on approach, allowing maximum control over asset selection and timing. But it’s essential to stay disciplined to avoid letting emotions interfere with investment decisions.
We’ve created a rebalancing tool that simplifies the rebalancing of your portfolio by calculating exact share adjustments based on new investments, updated prices, and target allocations.
Alternatively, automated tools—such as robo-advisors or certain brokerage features—can handle rebalancing for you, adhering strictly to preset guidelines. These automated solutions remove emotional biases and reduce the time and effort needed, making them an attractive option for busy investors or those new to portfolio management.
Considering Taxes and Fees When Rebalancing
It’s important not to overlook the impact of taxes and fees when you rebalance your investments. Frequent selling and buying can trigger capital gains taxes, especially in taxable accounts. To minimize tax implications, consider rebalancing within tax-advantaged accounts like an IRA or 401(k), where gains aren’t taxed until withdrawal.
Additionally, be mindful of transaction fees that can quickly add up—selecting low-cost funds and platforms with commission-free trading can help keep your rebalancing cost-effective.
What If You’re Already in a Balanced Mutual Fund?
If you invest in target-date funds or balanced mutual funds that maintain a fixed asset allocation—like 60% stocks and 40% bonds—you may not need to rebalance your portfolio manually. Fund managers automatically adjust the allocation over time to stay aligned with the fund’s objectives. This makes it an easy, hands-off way to keep your investments in check.
However, there’s a catch: if you’re holding these funds in a taxable account, the fund’s internal rebalancing can trigger capital gains distributions. These may show up as short-term or long-term capital gains on your tax return, even if you didn’t sell anything yourself.
While this doesn’t mean you shouldn’t use these funds, it’s worth being aware of the potential tax consequences—especially if you’re aiming for tax efficiency.
Maintaining Discipline for Long-Term Success
Ultimately, rebalancing is about maintaining discipline. It forces you to sell high and buy low—exactly the opposite of what emotions might tempt you to do during market swings. By sticking to a thoughtful rebalancing strategy, you’ll stay closer to your intended risk tolerance, helping your portfolio weather market volatility and grow consistently over the long term.
For more details on portfolio rebalancing and its implications, check out this comprehensive guide from Investopedia on Portfolio Rebalancing ↗.
And remember, it’s always a great idea to chat with your financial or tax advisor to make sure your decisions are right on track and aligned with the latest guidelines and laws.