Why portfolios drift and why rebalancing matters
Once you set an asset allocation, markets start changing it. Stocks and bonds grow at different rates, so a 60% stock target can become 70% after a few strong years or 50% after a crash. The SEC’s own example is a portfolio meant to hold 60% stocks that reaches 80% after a stock market rise.
Drift matters because it moves your risk away from your risk tolerance without your consent. The SEC notes that stocks have historically had the greatest risk and the highest returns of the three major asset categories, so a portfolio left alone for decades tends to become more stock-heavy. The extra risk often peaks as retirement nears, just when sequence of returns risk is highest.
Rebalancing is a risk-control habit first, not a return booster. It also imposes a useful discipline: the SEC points out that by trimming the current winners and adding to the current losers, rebalancing forces you to buy low and sell high.
How often to rebalance: calendar vs. threshold
The SEC describes two approaches. Calendar rebalancing checks the mix at a fixed interval, such as every six or twelve months, and trades back to target. Threshold rebalancing trades only when an asset class drifts more than a percentage you set in advance. The SEC adds that either tends to work best when done relatively infrequently, and FINRA suggests considering it once a year as part of an annual review of your investments.
Thresholds come in two forms. An absolute band triggers a trade when an asset moves a set number of percentage points from target, for example rebalancing a 60% stock target when stocks fall below 55% or rise above 65%. A relative band scales with the target, so a 25% band on a 20% allocation to international stocks triggers below 15% or above 25%.
Rebalancing too often adds trading costs and, in taxable accounts, can realize gains on shares held a year or less, which are taxed as short-term gains at ordinary income rates. Rebalancing too rarely lets risk wander.
Ways to rebalance without selling
Selling is only one tool. The SEC lists three ways to rebalance: sell overweight assets and buy underweight ones, buy more of the underweight asset with new money, or change where ongoing contributions go until the mix is back in line. Several other cash flows can do the same job with little or no tax. For regular savers, redirecting contributions alone can often hold a portfolio near target; after a large market move, it may need help from a sale.
- New contributions: point paycheck deferrals or deposits at the underweight asset until it catches up.
- Dividends and interest: take them as cash and invest them where the portfolio is short, which may mean switching off a dividend reinvestment plan.
- Retirement withdrawals: sell from whatever is overweight to fund the year’s spending.
- Required minimum distributions: choose which holdings to sell inside the IRA to raise the cash; the distribution is taxed the same either way.
- Tax-advantaged accounts: make the trades inside a 401(k) or IRA, where switching between funds is not a taxable sale.
Rebalancing and taxes
Where you rebalance decides whether it costs tax. IRS Publication 590-A says amounts in an IRA, including earnings and gains, generally are not taxed until distributed, and the same deferral applies inside a 401(k). Selling one fund and buying another there triggers no tax, which is one reason to hold the assets you trade most in tax-advantaged accounts, part of sound asset location.
In a taxable brokerage account, selling shares for more than your basis realizes a capital gain. Shares held more than one year produce long-term capital gains, which for 2026 are taxed at 0% to the extent your taxable income, including the gain, stays at or below $49,450 for single filers or $98,900 for married couples filing jointly, and at 15% or 20% above that. Shares held one year or less produce short-term gains taxed as ordinary income. A year when your income dips can be a cheap time to rebalance a taxable account.
Selling at a loss can offset gains through tax-loss harvesting, but mind the wash sale rule. Publication 550 disallows the loss if you buy substantially identical securities within 30 days before or after the sale, including a purchase in your own IRA or Roth IRA. In that IRA case, the disallowed loss is not added to the new shares’ basis, so it is simply gone.
Common rebalancing mistakes
Rebalancing rarely fails because of the wrong formula. It fails because investors skip it when it feels uncomfortable, overdo it when markets are noisy, or ignore the tax and account details. The hardest moment is after a crash, when restoring your target means buying the asset that just fell. A written rule decided while markets are calm, such as a yearly review date and a 5-point band, makes that step easier to follow.
- Rebalancing each account separately, which multiplies trades; manage one household target and trade where it is cheapest.
- Selling in a taxable account when new contributions or trades inside an IRA could do the same job.
- Rebalancing on market forecasts instead of a preset rule, which turns it into market timing.
- Forgetting that gains realized to rebalance raise income, which can lift Medicare IRMAA surcharges two years later.
Illustrative numbers
Restoring a 70/30 target after a strong year for stocks
- Target weight
- The share of the portfolio you want in that asset class, such as 30% bonds
- Total portfolio value
- The value of all accounts in the plan, after adding any new contributions
- Current value of that asset class
- What you hold in it today across those accounts
A positive result means buy that much; a negative result means sell it.
Starting portfolio at target$500,000: $350,000 stocks, $150,000 bonds
After stocks gain 30% and bonds 1%$455,000 + $151,500 = $606,500
Stock share after the move75.0%, outside a 5-point band
Fix by selling aloneSell $30,450 of stocks and buy bonds
Fix after sending $20,000 of new savings to bondsSell only $16,450 of stocks
Directing new money to the underweight asset cut the required sale by $14,000. That matters in a taxable brokerage account, where selling appreciated shares can realize a capital gain; inside a 401(k) or IRA, either version of the trade has no immediate tax cost.
At a glance
Rebalancing methods compared
| Method | How it works | Advantage | Drawback |
|---|---|---|---|
| Calendar | Trade back to target on a set date, such as once a year | Simple habit that is easy to remember | May trade when drift is tiny, or wait while it grows |
| Threshold | Trade when an asset drifts past a preset band | Trades only when it matters | Needs monitoring and can fire often in volatile markets |
| Calendar plus threshold | Check on a set date; trade only if outside the band | Few trades with drift kept in bounds | Drift can exceed the band between check-ins |
| Cash-flow | Send contributions, dividends or withdrawals to the underweight side | Little or no selling, so little tax | Too slow when balances dwarf new money |
| Fund-managed | A target-date or balanced fund rebalances itself | No effort needed | Covers only the money in that fund |
Put it in your plan
Rebalancing in MoneyWhatIf
MoneyWhatIf is an allocation model: each year an investment account’s return combines its stock and bond return assumptions at the bond share set for that year, so every projected year uses the mix you entered. Dated bond-allocation periods let the target itself change, for example from 20% bonds while working to 40% after retirement. Plan resilience can deal histories from a rebalanced 60/40 portfolio, and by default it switches from S&P 500 years while you work to that 60/40 blend in your first retired year.
Common questions
Rebalancing FAQs
What is the difference between rebalancing and reallocating?
Rebalancing returns a portfolio to the targets you already have; reallocating changes the targets themselves. You rebalance because markets moved. You reallocate because your life changed, such as a shorter time horizon, a new goal, or a shift in your risk tolerance or finances, which are the reasons the SEC gives for changing an allocation. A glide path is a planned series of reallocations, with rebalancing holding each step in between.
Should I rebalance during a market crash?
If your rule calls for it, generally yes, because rebalancing after a crash means buying stocks while they are down, which is how the strategy buys low. Make sure the next few years of planned spending are covered by cash and bonds first, so you are not buying stocks with money you will soon need. Skipping it leaves you with less stock than you planned if prices recover.
Does rebalancing improve returns?
Not reliably. Its main job is controlling risk. Over long periods when stocks beat bonds, a portfolio left alone drifts toward more stock and may earn more, with more risk, than a rebalanced one. Rebalancing can help when markets swing back and forth, because it trims what has risen and adds to what has fallen, but expect a steadier ride rather than a bonus.
What is the 5/25 rebalancing rule?
It is a threshold rule of thumb. You rebalance an asset class when it drifts 5 percentage points from its target or by 25% of its target weight, whichever band is narrower. A 60% stock target triggers below 55% or above 65%, while a 10% target triggers below 7.5% or above 12.5%. It is a convention, not a regulation.
Do I need to rebalance a target-date fund?
Not the fund itself. The SEC notes that in a target-date fund, the fund’s investment adviser takes care of rebalancing over time. You still need to check your household mix if you hold other funds alongside it, such as an S&P 500 fund in a brokerage account, because the fund rebalances only the money inside it.