What is rebalancing?
Rebalancing is returning your portfolio to your target allocation. If your target is 70% stocks and 30% bonds, but market performance has pushed you to 75% stocks and 25% bonds, rebalancing means selling stocks and buying bonds to get back to 70/30.
Why? Because drifting allocation changes your risk without your permission. And rebalancing forces you to sell winners (stocks) and buy losers (bonds) — a mechanical "buy low, sell high."
How often should you rebalance?
Most FIRE practitioners rebalance once per year. Some rebalance only when the allocation drifts more than 5% from target. Rebalancing more often (monthly or quarterly) adds trading costs and taxes without meaningful benefit.
When to rebalance
The best time is December, right before year-end. You can:
- Rebalance back to your target allocation.
- Harvest tax losses on any positions down in value.
- Make annual contributions to tax-advantaged accounts.
Combine these tasks into one annual ritual, and you are done investing for the year.
A rebalancing example
Start of year: target allocation is 70% stocks ($70,000) and 30% bonds ($30,000). Total: $100,000.
End of year: stocks have grown to $76,000, bonds to $29,000. Total: $105,000. Current allocation: 72% stocks, 28% bonds.
You have drifted 2% toward stocks. To rebalance: sell $2,100 in stocks, buy $2,100 in bonds. New balance: $73,900 stocks, $31,100 bonds. You are back to 70/30.
Rebalancing in taxable accounts
Rebalancing in taxable accounts triggers capital gains taxes. If you are selling stocks at a big gain, you will owe taxes. To minimise this:
- Rebalance by directing new contributions toward underweight assets (stocks if bonds grew too much).
- Harvest losses when available to offset rebalancing gains.
- Use tax-advantaged accounts (401k, Roth) for most of your investing if possible.
Rebalancing in tax-advantaged accounts
In 401ks and Roth IRAs, rebalancing has no tax cost. You can sell and buy freely. These accounts are the ideal place to rebalance aggressively.
The mechanical discipline
Rebalancing is one of the few times you will feel forced to "sell winners and buy losers." This is exactly right. A disciplined annual rebalance captures the mathematical benefit of contrarian investing: you are systematically buying depressed assets and selling inflated ones.
Mark it on your calendar. Once a year, spend 15 minutes rebalancing. Let the portfolio ride the rest of the year.