What Is Rebalancing?

Rebalancing is what investors do to bring their portfolio back to its original asset allocation mix. Rebalancing is needed because over time, some investments will grow faster than others. This may push your holdings out of alignment with your investment goals. By rebalancing, you will ensure that your portfolio does not overweight a particular asset category, and you’ll return your portfolio to a comfortable level of risk.

For example, you might start with 60% of your portfolio invested in stocks, but see that rise to 80% due to market gains. To reestablish your original asset allocation mix, you’ll either need to sell some of your stocks or invest in other asset categories.

There are three ways you can rebalance your portfolio:

  1. You can sell investments where your holdings are over weighted and use the proceeds to buy investments for underweighted asset categories.
  2. You can buy new investments for underweighted asset categories.
  3. If you are continuing to add to your investments, you can alter your contributions so that more goes to underweighted asset categories until your portfolio is back into balance.

Before you rebalance your portfolio, you should consider whether the method of rebalancing you decide to use would entail transaction fees or tax consequences. Your financial professional or tax adviser can help you identify ways that you can minimize these potential costs.

Some financial experts advise rebalancing at regular intervals, such as every six or 12 months. Others recommend rebalancing when your holdings of an asset class increase or decrease more than a certain pre-set percentage. In either case, rebalancing tends to work best when done on a relatively infrequent basis.

Shifting money away from an asset class when it is doing well in favor of an asset category that is doing poorly may not be easy. But it can be a wise move. By cutting back on current “winners” and adding more current “losers,” rebalancing forces you to buy low and sell high.