How to Rebalance a Portfolio

Rebalancing is selling some of what went up and buying some of what didn't, until the portfolio looks like the one you designed. The mechanics take ten minutes. The reason people don't do it is that it feels wrong every single time.

Here is how I do it, with the numbers, and the two or three places where the standard advice is incomplete.

Why a portfolio needs it at all

Portfolios drift. Winners grow as a share of the whole and losers shrink, so a portfolio you built as 60% stocks and 40% bonds becomes 70/30 after a good year for stocks without you lifting a finger. That's a different portfolio. It carries more risk than you decided you wanted, and it got there by accident.

Rebalancing puts it back. That's the whole purpose, and it's worth being precise about what it is not. It is not a bet that the winners are expensive and the losers are cheap. A position can grow past its target because earnings rose even faster than the price, and be cheaper than the day you bought it. Overweight doesn't mean overvalued. Rebalancing restores the risk allocation you chose; any benefit from things reverting to average is a side effect, not the point.

It's not "I think this sector is overvalued." It's "this sector is eight points over its target weight, so I'm trimming." Process beats prediction over time.

The two triggers, and the one I use

Time-based. Rebalance on a schedule: quarterly, twice a year, annually. Simple. It happens regardless of how the market feels. The weakness is that a portfolio can drift a long way between reviews, and it can also trigger trades you didn't need because the calendar said so.

Threshold-based. Rebalance whenever an allocation drifts more than a set number of percentage points from its target, commonly 5 to 10. Note that it's percentage points, not a relative move. If the target is 60% and the band is 5 points, you act at 65% or 55%, not at 63% because 63 is 5% more than 60. This only trades when something has moved, but someone has to be watching.

What I do. Both. Review on a schedule, act only when a threshold has been crossed. For broad asset allocation, stocks versus bonds versus cash, the calendar does most of the work. For individual positions inside the stock portion, the threshold does, because a single stock can double in a quarter and the calendar won't notice until it's a problem. Either method works on its own; consistency matters more than which one you pick.

A worked example

Say you started the year with $200,000, split 60/40: $120,000 in stocks, $80,000 in bonds. Stocks had a strong year and bonds didn't move much.

Asset	Now	Weight	Target	Drift
Stocks	$154,000	70.00%	60.00%	+10.00 pts
Bonds	$66,000	30.00%	40.00%	−10.00 pts
Total	$220,000	100.00%

Ten points of drift blows through a 5-point band, so you act. The target stock weight is 60% of $220,000, which is $132,000. You hold $154,000. Sell $22,000 of stocks and buy $22,000 of bonds.

That's it. Nobody needed an opinion about where the market is going.

The version where you don't sell anything

If you're still adding money, point the new contributions at whatever is underweight and let the deposits do the rebalancing. No sales, no realized gains, no tax bill. For anyone contributing regularly this is the most tax-efficient method there is, and it's the one I'd use first.

It has a limit, and the example shows it. To get that $154,000 in stocks back to 60% without selling any, the whole portfolio would need to be about $256,667, meaning roughly $36,667 of new money into bonds. If you're contributing $500 a month, that takes about six years. Contributions handle small, steady drift well. They can't fix a big move by themselves, and when the band is blown through you'll have to sell something.

Taxes, briefly

Every sale in a taxable account is a taxable event, and trimming winners means realizing gains. Three things follow.

Do your rebalancing inside the IRA or 401(k) first. A trade in a tax-advantaged account generally triggers no current capital-gains tax, so if the same drift exists in both places, fix it where it's free. Keep your most actively managed positions in those accounts for the same reason.

In taxable accounts, rebalance less often. Annual rather than quarterly, and use wider bands, because the cost of each trade is higher. And before you sell a winner, check its holding period. A gain on a position held more than a year is taxed at long-term rates; one held less than a year is taxed as ordinary income. If the anniversary is three weeks away, three weeks of drift risk is usually cheaper than the tax difference.

Rebalancing day is also a good day to look for losses you can realize to offset the gains you're taking. That's tax-loss harvesting, and it pairs naturally with trimming winners. I'm not a tax advisor and your situation is yours; the point is that the order you do things in matters, and the cheap account goes first.

Rebalancing a single stock, which is a different problem

Most writing on rebalancing is about asset classes. The version that bites individual-stock investors is one position growing until it's the portfolio.

Book Four's rule is a 5% maximum for any one stock. Say you opened a position at 3% and it doubled while the rest of the portfolio rose 10%. It's now about 5.45% of the whole, and it's over the line. The rule says trim, and the rule doesn't care that it's your best idea. I'd rather take it back toward the original weight than shave it to 4.9% and have the same conversation next month, but what matters is that you wrote the number down before the stock went up, because afterward every argument for keeping it will sound persuasive.

This is the threshold trigger doing its job. It fires on the position, not the calendar, and it's why I use thresholds inside the stock portion even when the broad allocation runs on a schedule.

When not to rebalance mechanically

The rule is the rule, but a rebalance is also a scheduled chance to ask a better question: does the original thesis still hold?

If a stock is underweight because the business is deteriorating, buying more of it to restore the weight is throwing good money after bad. Rebalancing assumes the targets are still right. A thesis that's broken changes the target, and the correct trade is to sell, not to top up. The same goes the other way: if you're trimming a winner purely because of weight and nothing about the company has changed, trim and move on. Don't let the trim turn into a judgment you haven't done the work to support.

Rebalancing fixes drift. It doesn't fix a wrong portfolio, and it isn't a substitute for the review that decides whether the portfolio is still right. Do that review at the same sitting, before you trade.

The part that's hard

You're selling what just made you money and buying what just lost it. The winner feels safe because it worked. The laggard feels uncomfortable because it didn't. Both feelings are backward, and that's exactly why the rule has to be written down in advance: the moment you most need to rebalance is the moment it feels least sensible.

Investors who never rebalance aren't guaranteed lower returns. They are guaranteed a portfolio whose risk drifted somewhere they didn't choose, and they'll find out where during the next bad year.

What to do with this

Write down three things. Your target allocation. The band that triggers a trade, in percentage points. And the date you'll review it, whether or not anything has moved. Then pull up your accounts and compute the current weights against the targets the way the table above does.

If nothing is outside its band, you're done, and you've learned your portfolio is roughly where you put it. If something is outside, fix it in the tax-advantaged account first, use new money second, and sell last. The whole job takes less time than you spent deciding what to have for lunch, and it's one of the few things in investing that works mostly because you did it rather than because you were right. Two related pieces on this site: what diversification actually means, which is what the targets are for, and position sizing and stop losses, which is where the 5% rule comes from.