Investment Rebalancing Strategies: Why, How, and When to Rebalance Investments

Why Rebalancing Matters

The goal of a rebalancing strategy is to keep your portfolio aligned with your financial plan while minimizing unnecessary downside risk. Over time, different asset classes and sectors rise or fall at different rates. Without rebalancing, portfolios can drift into unintended territory. For example, a portfolio designed to be 60% stocks and 40% bonds can quietly become 80% stocks and 20% bonds after a strong bull market. These changes may leave you with much more risk than you originally planned for.

Ultimately, rebalancing matters because it helps you stick to your investment strategy instead of letting market swings determine your future.

Rebalancing Strategies

Time-Based Rebalancing

• How it works: You rebalance on a set schedule, such as quarterly, semi-annually, or annually.
• Pros: Simple to follow and easy to automate since it’s tied to a calendar.
• Cons: May trigger unnecessary trades if your portfolio hasn’t drifted much, which can increase costs.
• Best For: Investors who want a disciplined, rules-based routine.
• Example: Rebalancing once a year in January.
• Watch Out For: Trading when allocations are already close to target.

Threshold-Based Rebalancing

• How it works: You rebalance only when your portfolio drifts a set percentage (for example, 5% or 10%) away from its target allocation.
• Pros: Keeps your allocation closer to its intended mix and only triggers rebalancing when it’s truly needed.
• Cons: Could lead to frequent trading in volatile markets or long stretches with no action if markets are stable.
• Best For: Investors who want allocations tightly managed.
• Example: Rebalancing if stocks drift more than 5% from target.
• Watch Out For: Extra trades and taxable conseqeuences during volatile periods.

Time + Threshold Rebalancing

• How it works: Combines the time-based and threshold-based approaches. You check your portfolio on a set schedule, and if allocations are off by more than your set threshold, then you rebalance.
• Pros: Helps balance discipline with efficiency, potentially lowering taxes and transaction costs compared to either strategy on its own.
• Cons: Requires more monitoring and effort, and research hasn’t shown it to be consistently superior to the other methods.
• Best For: Investors seeking balance between structure and efficiency.
• Example: Quarterly check-ins, rebalancing only if drift is more than 5%.
• Watch Out For: Extra time required to monitor consistently.

“Set It and Forget It”

• How it works: The portfolio is left alone. This results in the allocation becoming more aggressive as markets rise and facing steeper falls as markets decline.
• Pros: No trading costs, simple to follow, and may lead to higher long-term returns for investors with a high tolerance for risk.
• Cons: Increases volatility, exposes the portfolio to sharp losses during downturns, and can leave you with far more risk than originally intended. For most investors, this approach is not recommended.
• Best For: Investors with a very long time horizon and strong risk tolerance.
• Example: A 60/40 portfolio becoming 80/20 after a bull market without rebalancing.
• Watch Out For: Risk drifting far beyond your original comfort zone.

How Often Should You Rebalance?

So how often should you rebalance? There is no one-size-fits-all answer, but most investors benefit from reviewing their allocation on a set schedule. Rebalancing too often, such as monthly, can add unnecessary costs and taxes. On the other hand, waiting several years may expose you to more risk than you originally intended.

Some investors intentionally avoid rebalancing as part of a “set it and forget it” approach. By letting equities grow untouched, the portfolio naturally becomes more aggressive over time. While this strategy can lead to higher long-term returns for those with a strong tolerance for risk, it also increases volatility and can result in sharp losses during market downturns. For most investors, this approach is not ideal.

Another concern is the potential cost of rebalancing. Rebalancing can trigger capital gains taxes, add transaction costs, and requires time and discipline to monitor the portfolio. These costs should be weighed against the risks of letting your allocation drift too far.

A good rule of thumb is to review your portfolio quarterly, semi-annually, or annually, and to rebalance if your allocation has drifted meaningfully from your target investment allocation. This strikes a balance between keeping risk in check and limiting costs.

Choosing the Right Rebalancing Strategy

Vanguard’s research on portfolio rebalancing found that there isn’t one “perfect” method. Instead, what matters is choosing a strategy that’s consistent, reasonable, and aligned with your financial plan.

Safe Landing Financial’s rebalancing strategy uses a combination of a time + threshold rebalancing strategy. If the portfolio is still within its target range, sometimes only smaller adjustments are made if needed.

Ultimately, the best rebalancing approach depends on your unique financial goals, risk tolerance, and investment strategy. The key is not perfection, but instead staying disciplined to your rebalancing strategy that’s aligned to your financial plan.

If you’re unsure which approach is right for you, consider reviewing your portfolio with a financial planner that can help align your investment and rebalancing strategy with your long-term goals.

Safe Landing Financial Investing Guide
Vanguard Research: Rational rebalancing: An analytical approach to multiasset portfolio rebalancing decisions and insights
Financial Planning for Technology Professionals
Financial Planning for Approaching Retirement
Mega-Backdoor Roth Guide
Backdoor Roth Guide
Deferred Compensation Guide + Case Study
HSA Guide + Strategy for Reimbursement
RSU Guide + Strategy After Vesting