What is portfolio rebalancing?

Portfolio rebalancing is the process of realigning the weight of assets in your portfolio back to your target allocation. Over time, different asset classes grow at different rates, causing your portfolio to drift from its intended risk profile. Rebalancing brings it back in line — trimming positions that have grown beyond their target and adding to those that have lagged.

Rebalancing methods

Calendar rebalancing checks allocations at set intervals (quarterly, semi-annually, or annually). Simple to follow but may miss large mid-period deviations. Threshold rebalancing triggers trades when any asset class deviates by a set percentage (e.g., 5%) from its target. Rebalancing bands combine both: use a range (e.g., 40-50% for a 45% target) and rebalance only when the allocation breaches the band.

Tax implications

In taxable accounts, selling appreciated assets triggers capital gains taxes. To minimize tax impact, prefer rebalancing within tax-advantaged accounts (401(k), IRA) first. For taxable accounts, direct new contributions and dividends toward underweight assets before selling. This is known as cash flow rebalancing and can avoid taxable events entirely.

When to rebalance

Most advisors recommend rebalancing when an asset class deviates by 5% or more from its target, or at least once per year. Rebalancing too frequently increases transaction costs and potential tax bills. Rebalancing too rarely exposes you to unintended risk from overweight positions in volatile assets.

Related Resources