Portfolio Rebalancing: Protect Your Wealth from Risk

When you start your investment journey, you typically choose an asset allocation based on your risk tolerance. For example, you might decide on a split of 80% stocks and 20% bonds. However, as the market moves, this balance begins to shift.

If stocks have an incredible year and grow by 20%, while bonds stay flat, your portfolio might drift to 85% stocks and 15% bonds. Congratulations, you are wealthier! But you are also more exposed to risk than you planned. Portfolio rebalancing is the process of bringing those numbers back to your target.

Why Rebalancing is Essential

Rebalancing serves two main purposes: controlling risk and forcing you to "buy low and sell high."

1. Risk Management

The primary reason to rebalance is to ensure your portfolio doesn't become too aggressive. If your stock portion grows too large, a market crash will hit your total net worth much harder than you intended. Rebalancing brings you back to a risk level you are comfortable with.

2. Systematic Profit Taking

Rebalancing naturally forces you to sell parts of your assets that have performed well (selling high) and buy parts that have underperformed (buying low). It is a mathematical way to strip emotion out of your decision making.

When Should You Rebalance?

There are two common strategies for deciding when to take action:

• Time-Based: You check your portfolio on a fixed schedule, such as every six months or once a year. This is simple and easy to remember.
• Threshold-Based: You check your portfolio periodically but only rebalance if an asset class has drifted by more than a certain percentage (e.g., 5%). This reduces the number of trades you make, which can save on taxes and fees.

How to Audit Your Current Allocation

Before you can rebalance, you need a clear picture of where you stand today. Many investors lose track of their total allocation because they have money spread across multiple accounts—a 401(k), a Roth IRA, and a taxable brokerage.

Using our Asset Allocation Auditor can help you consolidate these numbers. It provides a birds-eye view of your holdings across different risk categories, making it easy to see exactly which areas need adjustment.

For a broader perspective on which income streams are worth pursuing in the current climate, our review of the Best and Worst Passive Income Ideas 2025 can help you decide where to allocate your newly rebalanced capital.

Transaction Costs and Taxes

Rebalancing is not free. When you sell assets in a taxable account, you may trigger capital gains taxes. To minimize this, consider these techniques:

• Rebalance with New Deposits: Instead of selling your best-performing assets, use your new monthly contributions to buy more of the underperforming assets until the balance is restored.
• Rebalance Inside Tax-Advantaged Accounts: Trading inside an IRA or 401(k) does not trigger taxes, making these accounts ideal for major adjustments.
• Be Mindful of Fees: Every trade has a cost. If your broker charges commissions, try to rebalance less frequently to keep your expenses low.

Final Thoughts

Rebalancing feels counter-intuitive to many people because it involves selling the assets that are doing the best. But this discipline is what separates professional investors from amateurs. By maintaining your target allocation, you ensure that your portfolio remains a resilient tool for long-term wealth building, rather than a gamble.

The Securities and Exchange Commission (SEC) offers official guidelines on why rebalancing is a critical task for individual investors.

Set a date on your calendar today—perhaps June 30th or December 31st—to audit your assets. Consistency in the boring, mechanical parts of finance is often the secret to extraordinary results.