Rebalancing
Rebalancing is the process of realigning the proportions of a portfolio back to its target asset allocation by selling assets that have grown beyond their intended weight and buying those that have fallen below.
Markets move continuously, and even a perfectly allocated portfolio drifts from its target over time. If you began 2020 with a 70% stock / 30% bond allocation and held through the subsequent market recovery, your portfolio might have shifted to 80% stocks by year-end as equities surged. That drift represents a departure from your intended risk level — you are now carrying more equity risk than you deliberately chose. Rebalancing corrects this by trimming positions that have grown and adding to those that have lagged.
Rebalancing serves two purposes. First, it is a risk management tool that keeps your portfolio aligned with your stated risk tolerance and investment goals. Second, and counterintuitively, systematic rebalancing enforces a 'buy low, sell high' discipline — you are automatically selling assets after they have risen and buying assets after they have declined, exactly the opposite of the emotional reaction most investors have.
There are two common rebalancing approaches. Calendar rebalancing means reviewing and adjusting the portfolio on a fixed schedule — quarterly, semi-annually, or annually. Threshold rebalancing means rebalancing only when an asset class drifts more than a specified percentage (say, 5%) from its target. Research suggests that threshold-based rebalancing often produces slightly better outcomes because it trades only when the drift is large enough to meaningfully affect risk exposure.
Inside tax-advantaged accounts like IRAs and 401(k)s, rebalancing is straightforward because no capital gains tax is incurred when selling appreciated assets. Inside taxable brokerage accounts, rebalancing by selling winners generates capital gains tax, which must be weighed against the benefit of maintaining target allocations. Strategies like redirecting new contributions to underweight positions — rather than selling overweight ones — can rebalance gradually without triggering taxes.
Target-date funds from Vanguard, Fidelity, and T. Rowe Price handle rebalancing automatically, which is one reason they are recommended as default investment options for investors who do not want to manage this process themselves.