Rebalancing your portfolio: How to rebalance | Vanguard (2024)

FAQs

How do you easily rebalance a portfolio? ›

One of the more popular strategies here is the 5/25 rule—where a rebalance is triggered when an investment allocation changes or drifts beyond a threshold % amount from the intended target. In this strategy the 5 portion means that if an allocation changes by 5% or more on an absolute basis it's time to rebalance.

Percentage-of-Portfolio Rebalancing

A preferred yet slightly more intensive approach to implement involves a rebalancing schedule focused on the allowable percentage composition of an asset in a portfolio. Every asset class, or individual security, is given a target weight and a corresponding tolerance range.

There is not a hard-and-fast rule on when to rebalance your portfolio. But many investors make it a habit to revisit their investment allocations annually, quarterly, or even monthly. Others decide to make changes when an asset allocation exceeds a certain threshold such as 5 percent.

With that in mind, let's look at how often you should rebalance if you use time-based rebalancing. The most common time frame that people use is annual rebalancing. They go in once a year to clean up their portfolio.

When or how often should you rebalance your portfolio? Our research (PDF) shows that optimal rebalancing methods are neither too frequent, such as monthly or quarterly calendar-based methods, nor too infrequent, such as rebalancing only every 2 years. For many investors, implementing an annual rebalance is optimal.

Rebalance in tax-advantaged accounts

Because rebalancing can involve selling assets, it often results in a tax burden—but only if it's done within a taxable account. Selling these assets within a tax-advantaged account instead won't have any tax impact.

One simple rule of thumb I tend to adopt is going by the 4-3-2-1 ratios to budgeting. This ratio allocates 40% of your income towards expenses, 30% towards housing, 20% towards savings and investments and 10% towards insurance.

So, too, does rebalancing improve performance, when all the portfolio's assets have the same long-term gains. However, the rebalancing benefits are not always large. With this study, rebalancing between 1) US stocks and bonds, and 2) US and foreign stocks produced less than 10 basis points of extra annual returns.

Smart rebalancing involves redistributing profits from assets with rapidly increasing value to other assets in the portfolio, ensuring a consistent increase in overall value.

What are the downsides of rebalancing? ›

Active rebalancing can also be expensive, as it involves trading fees and potential taxes. Each time an asset is bought or sold, investors must pay a trading fee or transaction costs. These fees can add up quickly, especially if an investor is frequently rebalancing their portfolio.

If you hold assets in tax-advantaged accounts like a 401(k) or IRA, you can rebalance by reallocating assets within these accounts. Since transactions within these accounts are not subject to capital gains taxes, you can sell overperforming assets and buy underperforming ones without triggering a tax event.

Restoring balance to your portfolio could involve selling some of your bond investments and buying stocks while they're cheap. Establishing a balanced portfolio and taking steps to keep it that way can help you to avoid relying too much on emotions when making important investment decisions.

Bottom Line. Rebalancing your portfolio is an important step towards reaching your financial goals. It reduces risk and ensures that your portfolio mix isn't out of balance. While some investors choose to rebalance manually, most choose automatic rebalancing for its simplicity and time-savings.

Rebalancing is an important way to help minimize volatility in a portfolio and may improve long-term returns.

Selling assets to rebalance a portfolio will generate trading costs and perhaps also capital gains taxes. Instead, investors should buy more stock with cash if they're underweighted in equities. "Use cash flow to optimize rebalancing," Hasan says. Market dips can also be an opportunity to rebalance with cash.

Rebalancing is the act of adjusting a portfolio's changed asset allocation to match an original allocation defined by an investor's risk and reward profile. There are several types of strategies for rebalancing, such as calendar, constant-mix, and portfolio-insurance.

In the end, rebalancing is a key practice for all investors. Knowing when to rebalance your portfolio can help ensure your money is working as hard as you are. Your investment strategy should reflect your goals, risk tolerance and time horizon.

You should consider adopting a portfolio rebalancing strategy—even during down markets when it's tempting to let your “winners” keep growing while your “losers” are taking their lumps. That's because rebalancing helps you buy low and sell high—an investing adage that's easy to say and hard to do.