Here’s When (and How) to Rebalance Your Investment Portfolio

If you were hoping for a one-size-fits all answer for the best time to rebalance a portfolio, I’m sorry to disappoint: Portfolio rebalancing is one of the most crucial yet debated aspects of investment management. While the concept is straightforward—returning your investment mix to your target allocation—the timing and frequency of rebalancing can spark heated discussions among financial experts. Let’s take a look at the different approaches out there, and which one might make sense for you.

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Understanding portfolio drift

Over time, your investment portfolio naturally drifts from its original allocation as different assets perform differently. For instance, during a bull market, your stock portion might grow significantly larger than your bond allocation, potentially exposing you to more risk than you initially intended. Conversely, during market downturns, your stock portion might shrink, possibly making your portfolio too conservative for your goals.

Different approaches to rebalancing

The main purpose of rebalancing your portfolio is less about improving returns and more about risk reduction. With that in mind, here are some of the ways you can concentrate your rebalancing efforts.

The calendar approach

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Many financial experts advocate for a simple, calendar-based rebalancing strategy, typically annually or semi-annually. This approach has several advantages:

The threshold approach

Others prefer threshold-based rebalancing, triggering adjustments when asset allocations drift beyond a certain percentage (often 5% or more) from their targets. This method:

When you might not need to worry

Successful rebalancing starts with a well-thought-out asset allocation strategy in the first place. Your allocation should reflect your risk tolerance, investment timeline, financial goals, and income needs. Certain investment vehicles and situations minimize the need for active rebalancing:

1. Target-date funds: These automatically rebalance and adjust their asset allocation as you approach retirement.

2. Robo-advisors: These digital platforms typically handle rebalancing automatically based on predetermined parameters.

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   Professionally managed accounts: If you work with a financial advisor, they usually manage rebalancing as part of their services.

So, rather than adhering strictly to either time-based or threshold-based rebalancing, simply review your portfolio at least annually—but avoid obsessing over minor fluctuations. Consider rebalancing when your allocation drifts significantly (5% or more) from your targets, particularly if you’re nearing retirement or have a lower risk tolerance.

Some more tips to keep in mind: Use new contributions to rebalance when possible, as this can minimize transaction costs and tax implications. And don’t forget about tax consequences—rebalancing in tax-advantaged accounts like 401(k)s and IRAs can help avoid capital gains taxes.

The bottom line

The best rebalancing strategy is one you’ll actually follow. While the debate between time-based and threshold-based rebalancing continues, the most important factors are understanding your investment goals and risk tolerance. Maintain a consistent approach and avoid emotional decisions during market volatility.

Whether you choose annual rebalancing or a threshold-based approach, the key is to stick to your long-term investment plan while ensuring your portfolio doesn’t drift too far from your intended asset allocation. Remember, the goal of rebalancing isn’t to maximize returns but to maintain the risk-return profile that aligns with your investment objectives.