When and How to Rebalance Your Index Funds
Left alone, a 70/30 portfolio drifts as winners grow. Rebalancing sells what's run up and buys what's lagged — enforcing 'buy low, sell high' as a rule rather than a guess.
Don't have time? Here's what you need to know:
- 1Rebalancing restores your target allocation after the market drifts it — its job is controlling risk, not boosting returns.
- 2Use calendar (once or twice a year) or threshold (drift beyond ~5 points) triggers; combining them works well and over-rebalancing just adds cost.
- 3Avoid the tax hit by rebalancing with new contributions and inside IRAs/401(k)s before ever selling in a taxable account.
- 4The two real mistakes are never rebalancing (letting risk creep up) and rebalancing constantly out of anxiety.
What Rebalancing Fixes
When you set a target allocation — say 70% stocks, 30% bonds — the market immediately starts pulling it off target. If stocks surge over a couple of years while bonds tread water, that 70/30 mix can quietly drift to 80/20. You're now taking more risk than you signed up for, just from doing nothing. Rebalancing is the act of selling some of what's grown and buying what's lagged to restore the original mix.
The point isn't to chase returns — it's to control risk. A portfolio that drifts to 80/20 will fall harder in the next downturn than the 70/30 you intended. Rebalancing keeps your actual risk aligned with the risk you chose, which is its real job. A useful side effect is that it forces a disciplined 'sell high, buy low' — you trim the asset that ran up and add to the one that's cheap.
Two Ways to Decide When
There are two standard triggers, and either works. Calendar rebalancing means checking on a fixed schedule — once or twice a year is plenty — and resetting to target. It's simple and easy to remember (many people use their birthday or year-end). Threshold rebalancing means acting only when an allocation drifts beyond a set band, commonly 5 percentage points: you rebalance a 70% stock target when it hits 75% or 65%, whatever the calendar says.
Threshold rebalancing reacts to what the market actually does and tends to be slightly more efficient, but it requires you to monitor. Calendar rebalancing requires no monitoring but may act when little has drifted. Many investors combine them: check annually, but only trade if something has crossed the band. Over-rebalancing — fiddling monthly — adds costs and taxes without improving results, so less is usually more.
| Method | Trigger | Pros | Cons |
|---|---|---|---|
| Calendar | Fixed schedule (e.g. annually) | Simple, no monitoring | May trade when little drift |
| Threshold | Drift beyond a band (e.g. 5%) | Reacts to real moves | Requires monitoring |
| Combined | Check annually, act only if over band | Best of both | Slightly more thought |
Tip: Once or twice a year is enough. Rebalancing more often adds trading costs and taxable events without meaningfully lowering risk.
How to Rebalance Without a Tax Bill
The catch with rebalancing in a taxable account is that selling an appreciated fund triggers capital gains tax. The good news is there are two ways to rebalance that avoid selling almost entirely. First, use new contributions: direct fresh money toward whatever asset is underweight until the mix is back on target. If stocks have run ahead, send new savings to bonds for a while. Second, rebalance inside tax-advantaged accounts: buying and selling in an IRA or 401(k) creates no tax, so do your trading there whenever possible.
If you hold the same asset classes across both taxable and tax-advantaged accounts, you can often restore your overall target by trading only inside the IRA — leaving the taxable account untouched. Reserve actual selling in a taxable account for when drift is large and contributions alone can't fix it.
Important: Selling appreciated funds in a taxable account to rebalance can create a capital-gains bill. Rebalance with new contributions or inside an IRA/401(k) first.
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A Simple Annual Routine
Here's a routine that takes fifteen minutes a year. Pick a date you'll remember. Pull up your accounts and total your stock holdings versus your bond and other holdings. Compare the actual percentages to your target. If nothing has drifted more than about 5 points, do nothing — drift inside the band isn't worth trading on. If something has, restore the target using new contributions first, then trades inside tax-advantaged accounts, and only sell in a taxable account as a last resort.
That's the entire discipline. The biggest mistake isn't choosing the wrong method — it's either never rebalancing (and letting risk creep up unchecked) or rebalancing constantly out of anxiety. Our guide on how to rebalance your portfolio walks through the mechanics step by step.
Frequently Asked Questions
How often should I rebalance my portfolio?
Once or twice a year is sufficient for almost everyone, or whenever an allocation drifts more than about 5 percentage points from target. Rebalancing more frequently adds trading costs and taxable events without meaningfully reducing risk — studies find annual and threshold-based rebalancing produce similar results. The exact cadence matters far less than having a rule and following it consistently.
Does rebalancing increase my returns?
Not reliably — rebalancing is a risk-control tool, not a return booster. Its main job is keeping your portfolio's risk aligned with your target instead of drifting toward more stocks (and more volatility) over time. In some periods the disciplined 'sell high, buy low' it enforces adds a little return; in others it slightly trims gains by selling the winner early. Expect steadier risk, not higher returns.
How do I rebalance without paying taxes?
Two methods avoid most of the tax. First, rebalance with new money: direct fresh contributions to whatever's underweight until the mix is back on target, so you buy rather than sell. Second, do your trading inside tax-advantaged accounts like an IRA or 401(k), where buying and selling triggers no tax. Reserve selling in a taxable account for when drift is large and contributions alone can't fix it.
Should I rebalance during a market crash?
Sticking to your rule during a crash is exactly when rebalancing pays off behaviorally — it means buying stocks while they're cheap, which is hard but historically rewarding. If your threshold is breached, rebalancing back to target is sound. The mistake is the opposite: abandoning your plan and selling stocks into the decline out of fear, which locks in losses and raises the bar for recovery.
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Alex Harrington
CFA Level II Candidate, Finance & Economics
Alex Harrington is an independent ETF researcher and personal finance writer with over 8 years of experience analyzing exchange-traded funds. A CFA Level II candidate with a background in economics, Alex has reviewed 800+ ETFs and helped thousands of beginners build their first investment portfolios through clear, jargon-free education.
This content is for educational purposes only and does not constitute financial advice. Past performance does not guarantee future results. Consult a licensed financial advisor before making investment decisions.