Rebalancing is the systematic process of returning your investment portfolio to its target asset allocation. Over time, different investments grow at different rates, causing your portfolio to drift away from your intended risk level. Rebalancing corrects this by selling positions that have grown too large and buying positions that have fallen below target, bringing your portfolio back into alignment with your investment strategy.
How It Works
Your portfolio has a target allocation—perhaps 60% stocks and 40% bonds, or a specific breakdown across asset classes. As markets move, these percentages shift. If stocks surge 20% while bonds grow 2%, you might end up with 70% stocks and 30% bonds. Rebalancing means selling some stocks and buying bonds to return to your 60/40 target. You can rebalance on a schedule (quarterly or annually) or when allocations drift beyond a threshold (e.g., when any position moves 5% from target).
Why It Matters for Investors
Rebalancing serves multiple critical functions. First, it enforces a disciplined approach to buying low and selling high—you're automatically trimming winners and adding to laggards. Second, it manages risk by preventing your portfolio from becoming too concentrated in high-performing assets. An investor who doesn't rebalance might unknowingly take on excessive stock market exposure during bull runs, only to face sharp losses when markets correct.
For angel investors and HNW individuals with diversified portfolios, rebalancing is especially important because early-stage investments can create outsized concentration. Regular rebalancing also has tax implications—strategic timing of sales can minimize capital gains taxes, though this requires coordination with your tax advisor.
Example
Imagine you start with a $1 million portfolio: $600,000 in stocks, $300,000 in bonds, and $100,000 in alternative investments. After two years, strong stock returns push your allocation to $750,000 stocks, $200,000 bonds, $50,000 alternatives. To rebalance to your 60/30/10 target, you'd sell $150,000 of stocks, buy $100,000 of bonds, and buy $50,000 of alternatives. You've locked in stock gains, restored your risk balance, and positioned for future growth.
Key Takeaways
- Rebalancing restores your portfolio to its target allocation and prevents unintended risk concentration
- Regular rebalancing forces disciplined buying and selling, often improving long-term returns
- Schedule rebalancing quarterly, annually, or when allocations drift significantly from targets
- Consider tax implications when rebalancing—use tax-advantaged accounts strategically to minimize capital gains