What is portfolio rebalancing?

It’s important to have a balanced portfolio — one that contains a mix of stocks, bonds and other investments in proportions that reflect your comfort with risk, time horizon and financial goals. To help maintain those proportions over time, you will need to periodically rebalance your portfolio.

Can my portfolio become out of balance even if I haven’t made any changes?

Yes. Since different markets tend to perform differently over time, market movements can change the percentage of stocks you own versus bonds in your portfolo.

Portfolio rebalancing hypothetical example

Imagine you have a portfolio worth $100,000 with the following allocation:

• 65% stocks ($65,000)
• 35% bonds ($35,000)

Over time, markets move, helping to grow the value of your assets and impacting your allocations:

• 75% stocks ($120,000)
• 25% bonds ($40,000)

Based on the new total portfolio value of $160,000, the percentage allocation between stocks and bonds no longer matches your target allocation of 65% stocks and 35% bonds.

How to rebalance a portfolio

There are a few ways to rebalance a portfolio, depending on your personal circumstances at the time. To bring your portfolio back toward your intended target weightings, consider these options:

1. Contribute new funds to investments that have become too underweight. If you have new money to invest, you can allocate those funds to areas that have become too underweight in your portfolio.

2. Withdraw funds from investments that have become too overweight. If you need cash from your portfolio for a personal circumstance, consider selling investments that have become too overweight.

3. Reallocate funds from investments that have become too overweight to investments that have become too underweight. If you don’t have new funds to invest and have no cash needs, consider selling investments that have become too overweight, using those funds to buy investments that have become too underweight.

While rebalancing is straightforward, when you rebalance a portfolio depends on a variety of factors.

How often should I consider rebalancing?

There are two methods to consider:

1. Calendar rebalancing — As its name implies, calendar rebalancing happens at regular intervals, such as annually.

2. Threshold rebalancing — You’ll rebalance when an investment strays too far from its target allocation by a certain amount. 

The main benefit of rebalancing is to help prevent your portfolio from wandering too far from its objectives and taking on too much risk, which could happen at any time of the year. Therefore, we favor threshold rebalancing — but we believe either method is preferable to not rebalancing at all. 

When should I change my desired portfolio balance?

Your desired portfolio balance, often referred to as asset allocation, should change at various points in your life or when your goals change. To illustrate: When you are younger and have many years to go until you retire, you have time to overcome the short-term market volatility that’s an inevitable part of investing. Consequently, you can likely afford to have a higher percentage of stocks in your portfolio, knowing that stocks offer more growth potential than other investments.

Once you’re retired, you may need to shift your focus somewhat from growth to income, increasing your allocation to bonds. Plus, you have fewer years to bounce back from volatile markets, and you don’t want to have to withdraw from your portfolio when your investments have lost value. So, when you retire, you may need to rebalance your portfolio to better align with your retirement goals.

How can I be prepared to rebalance when needed?

Your portfolio was designed to help meet your financial goals, and it’s important that your allocation still aligns with these goals to keep you on track. Develop a strategy with your financial advisor to review your portfolio’s asset allocation on a regular basis and rebalance when appropriate.

Are there tax consequences to rebalancing?

It’s possible. If you need to rebalance by selling some investments that have gained in value, you might incur capital gains taxes, assuming the investments were held in a taxable account.

If you need to scale back in certain types of investments that you own in both taxable and tax-deferred accounts, such as your 401(k) and IRA, you may want to sell the investments in the tax-deferred accounts first. Transactions within your 401(k) and IRA will be free of capital gains taxes, although withdrawals from these accounts may be subject to taxes. When you do start taking withdrawals, you’ll want to consult with your tax advisor.

Does rebalancing really pay off?

Portfolio rebalancing can pay off for investors when done correctly. By rebalancing, an investor can actively manage portfolio risk.

What are the downsides of rebalancing?

Rebalancing may result in potential taxes and/or trading costs associated with buying and selling investments. However, these costs should be weighed against the benefits of maintaining a balanced portfolio aligned with your comfort with risk, time horizon and financial goals. An Edward Jones financial advisor can provide you with more information on rebalancing.