“When should I rebalance my portfolio?” It’s one of the most common questions I get from clients, and for good reason: getting this wrong can leave you taking on more risk than you intended.
Portfolio drift is completely normal and inevitable. Markets move at different rates, so your carefully crafted 60/40 allocation will naturally shift over time. What I’ve observed in my practice is that retirees and pre-retirees typically fall into two camps: those who rebalance too often (costing themselves money in fees, taxes, waste of time) or those who never rebalance at all (taking on more risk than they realize).
The good news? There’s a sweet spot that most people can easily find. You’ll learn the two main rebalancing approaches and discover which one makes the most sense for your situation.
What Is Rebalancing and Why It Matters
Rebalancing simply means bringing your portfolio back to your target allocation. Let’s say you want a 60% stock, 40% bond portfolio. After a strong year in the stock market, you might find yourself at 70% stocks and 30% bonds. Rebalancing would mean selling some stocks and buying bonds to get back to your 60/40 target.
Here’s why this matters, especially for retirees: rebalancing forces you to systematically “buy low and sell high.” When stocks have run up (and are potentially expensive/overpriced), you sell some. When bonds have lagged (and might be relatively cheap), you buy more. It’s a disciplined approach that removes emotion from the equation.
For those in or approaching retirement, there’s another crucial benefit: risk management. Unlike younger investors who have decades to recover from market downturns, retirees can’t afford to let their portfolios become too aggressive. If that 60/40 portfolio drifts to 80/20 right before a major market crash, the damage might cause shortfalls to your desired retirement income.
Time-Based vs. Drift-Based: The Great Rebalancing Debate
There are two main schools of thought on when to rebalance, and I see merit in both approaches.
Time-Based Rebalancing: The Calendar Approach
With time-based rebalancing, you rebalance on a set schedule – quarterly, semi-annually, or annually, regardless of how much your allocation has drifted.
The biggest advantage is simplicity. Set a calendar reminder for January 1st each year for an annual rebalance, or January 1 and July 1 for semi-annual rebalance, and you’re done. No need to constantly monitor your portfolio or make complex decisions. This approach works particularly well for hands-off investors.
However, there’s a downside: you might rebalance when you don’t really need to. If your allocation has only drifted from 60/40 to 62/38, the rebalancing costs (trading fees, potential taxes, time) might outweigh the benefits. You might also
Drift-Based Rebalancing: The Threshold Approach
Drift-based rebalancing triggers action only when your allocation moves beyond predetermined limits. For instance, you rebalance when any asset class (or specific fund) drifts more than 20% from its target.
For a 60/40 portfolio, this means rebalancing when stocks hit either 72% (60% + 20% of 60%) or 48% (60% – 20% of 60%). Your bonds would trigger rebalancing at either 48% or 32%.
This approach ensures you only rebalance when one asset class, or fund, has done really well, and something else hasn’t done as well. In that way, you’re selling high and buying low. You’re also not making unnecessary trades, which keeps costs down and saves you time.
The challenge? It requires more monitoring. You need to check your allocation periodically to see if a position or asset class has exceeded the 20% threshold. This could be a pain for DIY investors, and might make you lean more towards a time based rebalance.
Which Approach Is Right for You?
In my experience, the answer depends on your personality and situation.
Choose time-based rebalancing if you:
•Prefer simplicity and want to “set it and forget it”
•Don’t want to monitor your portfolio regularly
•Tend to second-guess financial decisions
Choose drift-based rebalancing if you:
•Don’t mind checking your portfolio regularly (at least quarterly, if not more frequently)
Have significant assets in taxable accounts where unnecessary trades create tax bills
•Want to minimize trading costs and frequency
•Are comfortable riding out larger drifts in your portfolio
For most of my clients, I use a drift-based approach because historically the long term returns of a drift based rebalancing schedule have been better than a time based one. However, I have the tools to track this fairly easily, and it’s also my day job!
For new money coming into accounts (like a monthly contribution to an account), I simply direct those funds to whatever asset class or fund is most underweight at the time. This “rebalancing through contributions” approach is incredibly efficient and avoids unnecessary trading.
It’s also worth noting that I don’t just look at the broad stock-to-bond allocation when rebalancing. I typically recommend a diversified portfolio of about 8-9 different ETFs covering various asset classes—domestic stocks, international stocks, different types of bonds, and so on. When I rebalance, I’m looking at each individual fund’s allocation relative to its target. By keeping each fund in line, the overall stock-to-bond ratio naturally stays balanced too.
When NOT to Rebalance
Just as important as knowing when to rebalance is knowing when not to. The most frequent, and most consequential reason not to rebalance is if most or all of your money is in taxable accounts. Either an Individual account, a Joint account, or a Trust account would all qualify. If you have significant capital gains in those accounts (and if you’ve been invested the last 15 years, it’s likely that you do have some solid gains), then I can’t necessarily recommend you rebalance. Especially without looking at your individual situation. Perhaps it makes sense to rebalance and pay taxes on the gains you made, but it also might make more sense to keep the uneven allocation, let the “winners” continue to accumulate, and not force a rebalance. If you’re unsure if a rebalance is worth it in your taxable accounts, I highly recommend you run the numbers with a financial planner.
Your Action Plan
Here’s what I recommend: First, decide on your approach. If you want simplicity, commit to a time based rebalancing approach like annual or semi-annual. If you prefer the drift threshold method, check your allocations (or positions) at least quarterly and use the 20% drift rule.
Second, know where to rebalance. Start with tax-advantaged accounts (like IRAs and 401K) where there are no tax consequences when you buy/sell securities. In taxable accounts, consider whether it makes sense tax wise to rebalance those accounts. Do not do it alone if you aren’t sure what you’re doing.
Finally, don’t let perfect be the enemy of good. A simple rebalancing strategy that you actually follow is infinitely better than a complex one that you abandon after six months. You are in this for the long haul, so make sure it’s something you can commit to.
Remember, small drifts are completely normal and nothing to lose sleep over. The goal isn’t perfection, it’s simply maintaining a risk level that lets you sleep well at night while staying on track for your retirement goals.
The key is finding an approach that matches your personality and sticking with it consistently. Whether you choose the calendar or the drift threshold method, you’ll be ahead of the majority of investors who either never rebalance or do it haphazardly based on emotions.