How and when to rebalance your portfolio (without paying extra tax)

Short answer: rebalancing means selling a little of what has grown and buying what has lagged, so your portfolio returns to the mix you chose. Do it on a schedule, such as once a year, or when an asset class drifts more than about 5 percentage points from its target. You can often avoid selling altogether by directing new money to the underweight part, and in a taxable account you should watch the tax cost of selling winners.

Why does a portfolio drift?

Different investments grow at different speeds. A portfolio that starts at 60% stocks and 40% bonds can end up at 70% stocks after a long rally, which means it is carrying more risk than you chose. Rebalancing resets the risk, not the return. It does not promise higher returns. It stops a portfolio from quietly becoming riskier than you planned. For how to choose the target in the first place, see asset allocation.

A worked example

You hold $100,000 split 60% stocks ($60,000) and 40% bonds ($40,000). In a good year stocks rise 30% and bonds rise 2%.

To get back to 60/40 on $118,800 you need $71,280 in stocks and $47,520 in bonds. That means selling $6,720 of stocks and buying $6,720 of bonds. Your portfolio is back where you wanted it, and you have locked in a little of the gain by moving it into the steadier part.

When should you rebalance?

• On a calendar. Once or twice a year, such as every January or on your birthday. It is simple and hard to forget. More frequent rebalancing adds trading and tax costs without a clear benefit.
• By threshold. Rebalance whenever an asset class strays more than a set amount, often 5 percentage points, from its target. This reacts to big moves and ignores small ones.
• A mix of both. Check once a year, and rebalance only if something is outside the band.

How do you rebalance without a big tax bill?

1. Use new contributions first. Put each new deposit into whichever asset class is below its target. Often this fixes the drift without selling anything.
2. Rebalance inside tax-advantaged accounts. In a 401(k), IRA or HSA, selling and buying does not trigger capital gains tax, so do your main rebalancing there. To see how those accounts rank, read our guide to Roth vs traditional IRAs.
3. Mind taxable accounts. Selling winners in a regular brokerage account can create taxable gains. Selling something held longer than a year is usually taxed at lower long-term rates, and selling at a loss can offset gains, subject to the rules.
4. Redirect dividends. Send dividends and interest to the underweight asset instead of automatically reinvesting them.

Are there simpler options?

A target-date or balanced fund rebalances for you inside the fund, which is one reason people like them. If you hold your own mix of funds, some brokers also offer automatic rebalancing. Either way, check the fees, since an extra layer of cost can cancel the convenience. For why costs matter, see expense ratios explained.

Common mistakes

• Rebalancing too often. Monthly changes mostly create cost and effort.
• Never rebalancing. A portfolio left alone for a decade can end up far riskier than you intended, just before you need the money.
• Rebalancing on emotion. Selling stocks after a fall because you feel worried is not rebalancing. A real rebalance after a fall means buying stocks, which is hard, and is why a rule written in advance helps.

General education, not investment or tax advice. Tax rules vary by account and situation, so check with a qualified professional before selling in a taxable account.

Frequently asked questions