Account Rebalancing 101
Account rebalancing is a concept most investors have heard of, but fewer fully understand how and when it should actually be used. It is often presented as a best practice that everyone should follow, yet in reality, rebalancing is more nuanced than that.
Rather than being an automatic good or bad decision, rebalancing is a tool. When used thoughtfully, it can help shape how a portfolio behaves over time. When used too aggressively or without considering taxes and costs, it can create unintended downsides.
In this post, we will explore what account rebalancing is, why investors pay attention to it, and what trade-offs should be considered before putting a rebalancing strategy into practice.
What Is Account Rebalancing?
Account rebalancing is the process of adjusting the investments in your portfolio to bring them back in line with a target allocation.
For example, an investor may design a portfolio to hold 70 percent in stocks and 30 percent in bonds. Over time, strong stock market performance could shift that balance to 80 percent stocks and 20 percent bonds. Rebalancing would involve trimming some stock exposure and reallocating toward bonds to restore the original mix.
At its core, rebalancing is not about predicting which investment will perform best next. It is about maintaining the structure of a portfolio as markets move and allocations naturally drift.
3 Reasons Why Investors Rebalance
Managing Portfolio Behavior and Volatility
When rebalancing is described as a way to “manage risk,” the risk in question is not usually the risk of total capital loss. Instead, it is about portfolio volatility, or how much the portfolio’s value moves up and down over time.
As certain asset classes grow larger than intended, the portfolio may become more volatile or concentrated than originally planned. Rebalancing can help bring the portfolio back toward its intended risk profile by realigning allocations.
It is important to note that this logic generally applies to diversified, fund-based portfolios, such as those built with index funds or broad asset classes. The same approach does not translate cleanly to portfolios made up of individual stocks. Selling a winning stock simply because it has gone up, and reallocating to a stock that has declined, could actually increase risk if the underlying business is deteriorating.
Reinforcing Discipline Over Emotion
Rebalancing can also act as a behavioral guardrail. Markets tend to reward recent winners, which can tempt investors to let concentrations grow unchecked. A structured rebalancing process encourages decisions based on a predefined strategy rather than short-term market narratives.
That said, discipline does not mean constant action. Thoughtful restraint is just as important as consistency.
Shaping Long-Term Portfolio Outcomes
Rebalancing is often misunderstood as a way to improve performance. In reality, it can sometimes reduce returns by selling assets that continue to perform well, triggering taxes, or reallocating into areas that lag.
A more accurate way to think about rebalancing is as a way to shape how a portfolio behaves over time, rather than maximize performance at all costs. It is about maintaining balance, managing concentration, and keeping the portfolio aligned with its intended structure, even if that means accepting trade-offs along the way.
Why Portfolios Drift Over Time
Portfolio drift is not a sign of neglect. It happens even in well-managed portfolios.
Different asset classes grow at different rates, and markets rarely move in perfect alignment. Contributions, withdrawals, dividends, and equity compensation events can further shift allocations across accounts.
Over time, this drift can meaningfully change how a portfolio behaves, sometimes in ways the investor did not originally intend.
When Should You Rebalance?
There is no single rule for when rebalancing should occur, but most approaches rely on clear guidelines rather than gut feelings.
Time-based rebalancing involves reviewing and adjusting a portfolio on a regular schedule, such as annually or semiannually. This approach emphasizes consistency and avoids reacting to short-term market noise.
Threshold-based rebalancing focuses on portfolio drift instead of the calendar. Under this method, adjustments are made only when an asset class moves beyond a predefined range, such as five percentage points away from its target allocation.
In practice, many investors use a combination of these approaches. However, it is important to recognize that rebalancing too frequently can be detrimental, particularly if it leads to repeated transaction fees, unnecessary trading, or tax consequences. Before implementing any rebalancing strategy, investors should understand the costs involved and whether the benefit justifies the activity.
Life events can also prompt a reassessment. Changes such as a job transition, equity compensation event, large purchase, or approaching a financial milestone may warrant a review of portfolio allocations, even if markets themselves have been relatively stable.
Tax and Cost Considerations
Rebalancing decisions should never be made in isolation from taxes and fees.
In taxable accounts, selling appreciated investments can trigger capital gains taxes, potentially reducing after-tax returns. Transaction fees and trading costs can further compound the impact if rebalancing is done too often.
In some cases, rebalancing can be handled more efficiently by directing new contributions, reinvesting dividends, or adjusting allocations within tax-advantaged accounts. Looking at all accounts together, rather than each account in isolation, often creates more flexibility.
Final Thoughts: A Tool, Not a Rule
Account rebalancing is not a one-time task or a universal mandate. It is a tool that can help manage portfolio behavior, risk exposure, and alignment with long-term goals when used intentionally.
The key is balance. Rebalancing too little can allow risk to drift unchecked. Rebalancing too much can introduce unnecessary taxes, fees, and performance drag. The right approach depends on portfolio structure, account types, costs, and personal circumstances.
At DiversiFi, we help clients evaluate rebalancing decisions within the broader context of their financial lives, not as a mechanical exercise.
If you are unsure whether your current portfolio is aligned with your goals or whether rebalancing makes sense for your situation, connect with us to get a thoughtful review of your situation and some clarity about moving forward.
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