Video Lesson
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What Is Rebalancing and Why Does It Matter?
Over time, winners grow larger and drift your portfolio away from your intended allocation. A 70/30 stock/bond portfolio can shift to 85/15 after a strong bull market, meaning you're taking significantly more risk than planned. Rebalancing sells some stocks and buys bonds to restore your original balance and risk profile.
The Hidden Benefit: Systematic Buy Low, Sell High
Rebalancing forces you to sell what has grown expensive and buy more of what has fallen. This systematically implements buy low, sell high behavior without requiring any market timing judgment. Over long periods, regular rebalancing adds a measurable return bonus on top of its primary risk management purpose.
When to Rebalance: Two Approaches
- Calendar rebalancing: once or twice per year on a fixed schedule — simple and predictable
- Threshold rebalancing: when any asset class drifts more than 5% from target — more responsive
Either approach beats no rebalancing. Consistency matters more than which method you choose.
How to Rebalance: Practical Methods
- Sell overweight assets and buy underweight in tax-deferred accounts (no tax consequences)
- In taxable accounts, direct new contributions to underweight assets before selling anything
- Use dividends and interest payments to buy underweight assets
- Keep your target allocation written down and review annually
Transaction Costs and Tax Efficiency
Over-rebalancing in taxable accounts generates capital gains taxes that can outweigh the benefit. Start with tax-advantaged accounts, use new contributions in taxable accounts, and only sell in taxable accounts when drift is significant. Once or twice per year is sufficient for most investors.