Every portfolio has a target mix (some percentage in stocks, some in bonds, maybe some in other assets) chosen to match how much risk you're willing and able to take. The problem is that markets don't respect your target. Stocks and bonds grow at different rates, and left alone, your portfolio slowly drifts away from the mix you originally chose.
Rebalancing is the process of periodically nudging your portfolio back to its target allocation. It sounds like a small maintenance task, and mechanically it is. But skipping it for long enough can leave you carrying meaningfully more risk than you ever agreed to.
Why drift happens, and why it matters
Imagine you start with a simple 80/20 portfolio: 80% stocks, 20% bonds. Over the next several years, suppose stocks return an average of 9% annually and bonds return an average of 3% annually, a plausible, if simplified, long-run gap.
| Year | Stocks (started 80%) | Bonds (started 20%) | Actual mix |
|---|---|---|---|
| 0 | $8,000 | $2,000 | 80% / 20% |
| 5 | $12,310 | $2,319 | 84% / 16% |
| 10 | $18,948 | $2,687 | 88% / 12% |
| 15 | $29,159 | $3,116 | 90% / 10% |
Nobody made an active decision to take on more risk here. It happened passively, purely because stocks grew faster than bonds. By year 15, this investor is carrying a 90/10 portfolio while believing they still hold an 80/20 one. It's a meaningfully more volatile position that will fall harder in the next downturn than they may have signed up for.
Drift is invisible until it isn't
The risk of drift doesn't show up on a statement. Your balance just keeps going up. It shows up the next time the market falls sharply, when a portfolio that's quietly become far more stock-heavy than intended drops far more than expected. See investment risk explained for how allocation and volatility relate.
This works in reverse too: after a stock market crash, your allocation can drift the other way, leaving you under-invested in stocks right as they've become cheaper, exactly when you'd ideally want more exposure, not less.
The three ways to rebalance
1. Sell high, buy low (the direct method). Sell a portion of whatever has grown beyond its target percentage, and use the proceeds to buy whatever has fallen below its target. This restores your exact target mix immediately, but it can trigger taxes in a taxable brokerage account (selling an investment that's gained value generally realizes a taxable gain) and may involve trading costs.
2. Direct new contributions (the quiet method). If you're still adding money (through a paycheck contribution to a retirement account, for example), you can rebalance simply by sending future contributions to whichever asset class has fallen behind, until the mix evens out on its own. No selling required, no tax consequences, and it works especially well in 401(k)s and IRAs where you're contributing regularly anyway.
3. A blend of both. Use new contributions to close most of the gap, and only sell existing holdings for whatever the contributions can't cover. This is the most tax-efficient approach for anyone investing in a taxable account, and it's worth pairing with tax-loss harvesting if you do need to sell a position at a loss along the way.
Rebalance inside tax-advantaged accounts first
If you hold both a taxable brokerage account and a tax-advantaged account like an IRA or 401(k), do your selling-based rebalancing inside the tax-advantaged account whenever possible. Trades inside those accounts don't trigger capital gains taxes, so you get the full benefit of rebalancing with none of the tax cost.
How often should you actually do this
There are two competing philosophies, and both work well enough that the choice mostly comes down to personal preference.
Calendar-based rebalancing means checking and correcting your allocation on a fixed schedule. Annually is the most common choice, sometimes semi-annually. Pick a date that's easy to remember, like your birthday or the start of the year, check your allocation, and adjust if it's drifted meaningfully.
Threshold-based rebalancing means you don't check on a schedule at all. Instead, you rebalance whenever an asset class drifts a set amount away from its target, commonly 5 percentage points. A popular version is the "5/25 rule": rebalance if an asset class moves 5 percentage points in absolute terms, or 25% of its own target value, whichever comes first. Under this rule, a 20% target bond allocation would trigger a rebalance if it drifted to either 15% (a 5-point absolute move) or 25% (a 25% relative move on a small target), whichever threshold is crossed first.
| Approach | Pros | Cons |
|---|---|---|
| Calendar-based (annual) | Simple, one date to remember, low effort | May rebalance unnecessarily in calm years, or too late in volatile ones |
| Threshold-based (5% band) | Responds precisely when it matters | Requires checking your allocation more frequently to catch the trigger |
| Combined (check annually, act on threshold) | Balances effort and precision | Slightly more to remember than either alone |
For most people, the combined approach is the practical sweet spot: check your allocation once a year, and only actually trade if you've drifted past your threshold. This keeps the whole process to a single 15-minute task most years, while still catching the years where drift got out of hand.
Key takeaway
Don't rebalance more often than that. Frequent rebalancing (monthly, or every time the market moves) adds trading costs and taxes without meaningfully improving your risk control. Drift takes years to become a real problem; your response can be just as unhurried.
A simple annual rebalancing checklist
- Pull up your total holdings across every account: 401(k), IRA, taxable brokerage, and any HSA you invest through.
- Calculate your current percentage in each asset class (stocks, bonds, and any others you hold), combined across all accounts.
- Compare that to your target allocation. If you're not sure what your target should be, see asset allocation by age for a starting framework.
- If you've drifted past your threshold, direct new contributions toward the underweight category first.
- If contributions alone won't close the gap, sell a portion of the overweight category (preferably inside a tax-advantaged account) and buy the underweight one.
- Set a reminder for the same time next year.
Start with your target
Rebalancing only works if you know what your target allocation should be in the first place. If you haven't settled on one, start with asset allocation by age, or see the three-fund portfolio for one of the simplest, most rebalance-friendly portfolio designs available.
Frequently asked questions
Do I have to sell investments to rebalance?
Not necessarily. If you're still contributing new money, you can often rebalance just by directing new contributions toward whatever category has fallen behind, without selling anything. Selling is only required when contributions alone aren't enough to close the gap, or when you have no new money coming in.
Does rebalancing hurt my returns?
It can slightly reduce returns in a period where one asset class (usually stocks) massively outperforms everything else, since rebalancing trims your winner. But its purpose is to control risk, not to maximize returns. You're trading a small amount of potential upside for a portfolio that matches the risk level you actually chose.
Should I rebalance during a market crash?
Often, yes. A crash is one of the clearest rebalancing signals, since stocks fall and bonds typically hold up better, pushing your allocation away from target. Rebalancing in a downturn means selling relatively strong bonds to buy relatively cheap stocks, which is the mechanical version of 'buy low.' See what to do in a market crash for the full playbook.