Rebalancing
You built a three-fund portfolio with a 48/32/20 split across U.S. stocks, international stocks, and bonds. You picked that mix because it matches the risk you can handle in a crash. But the market doesn’t care about your plan. Stocks and bonds grow at different rates, and after a year your carefully chosen allocation looks nothing like what you set up. An 80/20 stock/bond split drifts to 85/15 or 75/25 all on its own. Rebalancing is the annual reset that puts it back.
What Rebalancing Actually Is
Section titled “What Rebalancing Actually Is”Your portfolio drifts because different investments grow at different rates. That’s not a flaw. It’s how markets work.
Say you started the year with 80% stocks and 20% bonds. Stocks returned 20% and bonds returned 3%. Your stock portion grew faster, so by year-end you’re sitting at roughly 84% stocks and 16% bonds. You didn’t change anything. The market changed it for you.
Rebalancing is the act of bringing those numbers back to 80/20. You sell some stocks and buy some bonds. That’s the whole concept.
The counterintuitive part is what that trade actually means. You’re selling the thing that did well and buying the thing that lagged. Every instinct says this is backwards. Stocks are winning, so you sell stocks? Bonds barely moved, so you buy more bonds? Yes. Because the point was never to chase performance. The point was to maintain the risk level you chose in Asset Allocation. Your 80/20 split wasn’t a guess. It was the amount of stock market volatility you decided you could stomach in a crash. Drift erodes that decision silently.
Left alone, a portfolio that starts at 80/20 can drift to 90/10 over a few strong stock years. At 90/10, a 40% stock crash wipes out 36% of your portfolio instead of 32%. That four-point difference on a $100,000 portfolio is $4,000 more in losses. Losses that might be the difference between holding steady and panic-selling everything at the bottom.
Why Bother
Section titled “Why Bother”Rebalancing is risk management. Full stop.
Most people assume it boosts returns. It usually doesn’t. Some years rebalancing helps your returns, some years it hurts, and over long periods it’s roughly a wash. What rebalancing does is keep your risk profile from drifting behind your back.
Think of it like adjusting the thermostat. You set it to 72 degrees. The temperature drifts to 78. You don’t leave it there just because 78 happened naturally. You set it back to 72 because 72 is the temperature you chose for a reason.
Your allocation works the same way. You chose 80/20 because you tested yourself against a crash scenario. Maybe you used the “110 minus your age” starting point. Whatever your method, you landed on a number that balanced growth with sleep-at-night comfort. Drift undermines that balance. A portfolio that has silently crept to 90/10 will hit you harder in the next downturn than you planned for, and that surprise is when people make permanent mistakes.
The years when rebalancing feels the most wrong are the years when it matters the most. After a massive stock rally, selling stocks to buy bonds feels like leaving money on the table. After a crash, selling bonds to buy stocks feels like catching a falling knife. Both are exactly what you should do.
How to Do It
Section titled “How to Do It”Pick a date. The same date every year. Your birthday, New Year’s Day, tax day, the first Saturday in October. It does not matter which day. What matters is that you pick one and actually do it.
On that day, log in to your brokerage account and compare your current allocation to your target. If you started with 48% U.S. stocks, 32% international stocks, and 20% bonds, check what those numbers are now. If any fund has drifted more than 5 percentage points from its target, make trades to bring each fund back to its individual target.
That’s the calendar method. Once a year. No monitoring in between.
Some people use a threshold method instead: rebalance whenever any asset class drifts more than 5 percentage points from its target, regardless of the calendar. This is fine, but it requires checking your portfolio more often, which creates more opportunities to fiddle with things you should leave alone. Once a year is enough. More frequent rebalancing isn’t more disciplined. It’s more trading, more tax events, and more chances to second-guess your plan.
In a tax-advantaged account (IRA or 401k): Rebalance freely. There are no tax consequences to selling and buying within these accounts.
In a taxable brokerage account: Selling triggers capital gains taxes. Two ways around that. First, direct new dollar cost averaging contributions toward whichever fund is below its target until the allocation corrects itself. Second, if you must sell, sell positions you’ve held for more than a year to qualify for the lower long-term capital gains rate. Rebalancing with new money is almost always better than selling.
A Year of Drift
Section titled “A Year of Drift”Numbers make this concrete. Say you’re 30 years old with $10,000 in a three-fund portfolio, split 48/32/20 across U.S. stocks, international stocks, and bonds.
Starting allocation on January 1:
| Fund | Target | Amount |
|---|---|---|
| U.S. Stocks | 48% | $4,800 |
| International Stocks | 32% | $3,200 |
| Bonds | 20% | $2,000 |
| Total | 100% | $10,000 |
Now a year passes. U.S. stocks return 22%, international stocks return 8%, and bonds return 3%.
Ending allocation on December 31 (no rebalancing):
| Fund | Amount | New Allocation | Target | Drift |
|---|---|---|---|---|
| U.S. Stocks | $5,856 | 52.0% | 48% | +4.0% |
| International Stocks | $3,456 | 30.7% | 32% | -1.3% |
| Bonds | $2,060 | 18.3% | 20% | -1.7% |
| Total | $11,372 | 100% |
Your portfolio grew to $11,372. But your allocation shifted. U.S. stocks now make up 52% instead of 48%. Bonds shrank from 20% to 18.3%. Your stock/bond split moved from 80/20 to nearly 83/17. You’re taking more risk than you planned.
Rebalancing trades:
| Fund | Current Amount | Target Amount (of $11,372) | Trade |
|---|---|---|---|
| U.S. Stocks | $5,856 | $5,459 | Sell $397 |
| International Stocks | $3,456 | $3,639 | Buy $183 |
| Bonds | $2,060 | $2,274 | Buy $214 |
You sell $397 of U.S. stocks. You use that money to buy $183 of international stocks and $214 of bonds. Three trades. Fifteen minutes.
After rebalancing:
| Fund | Amount | Allocation |
|---|---|---|
| U.S. Stocks | $5,459 | 48% |
| International Stocks | $3,639 | 32% |
| Bonds | $2,274 | 20% |
| Total | $11,372 | 100% |
Back to your target. Same total value. You didn’t add or remove any money. You just moved it between funds.
Where This Breaks
Section titled “Where This Breaks”Taxes in a taxable account. That $397 sale of U.S. stocks in the example above? If those shares appreciated, you owe capital gains tax on the gain. In a 401(k) or IRA, this isn’t an issue. In a taxable account, it’s real money. The workaround is directing new contributions to the lagging funds instead of selling winners, but this only works if your contributions are large enough relative to your portfolio to actually move the needle. Once your portfolio reaches $100,000 or more, new contributions of $500 a month won’t rebalance meaningful drift on their own.
The emotional difficulty is real. After watching U.S. stocks crush everything else for years, selling U.S. stocks to buy underperforming international stocks feels like punishing the winner. Your brain screams that U.S. stocks will keep winning and international stocks will keep losing. That’s recency bias talking. The last decade’s winner has historically been a poor predictor of the next decade’s winner. You’re not making a bet on which asset class does best. You’re maintaining the diversification that protects you when the leader changes.
Years when everything falls together. In 2022, U.S. stocks dropped 19% and bonds dropped 13%. When every asset class falls, drift is smaller because nothing rose dramatically relative to anything else. You still check. You may not need to trade at all. If drift is small in any given year, under 3 percentage points in any fund, skip it. Perfect allocation isn’t the goal. Approximately right, maintained consistently, is the goal.
Try It Now
Section titled “Try It Now”- Write down your target allocation (e.g., 48% U.S. stocks, 32% international, 20% bonds)
- Pick your annual rebalancing date and add a recurring calendar reminder
- Log in and check your current allocation against your target
- If you’re in a taxable account, direct your next few contributions to whichever fund is furthest below its target
What’s Next
Section titled “What’s Next”Where you hold your funds changes how much of your returns you keep. A dollar of bond interest in a taxable account gets taxed every year. The same dollar in an IRA grows untaxed for decades. Tax-Advantaged Accounts covers IRAs, 401(k)s, and how to place your funds in the right accounts to keep more of what you earn.