Portfolio rebalancing means periodically buying and selling assets to restore your target allocation — for example, selling stocks that have grown beyond their target weight to buy bonds. It controls risk by preventing your portfolio from drifting into a riskier allocation than you intended.
Portfolio rebalancing is the process of realigning the weights of assets in a portfolio to maintain the original target asset allocation. When stocks outperform bonds, the portfolio drifts toward a higher equity weight — and higher risk — than intended. Rebalancing sells the winners and buys the losers to restore the target mix.
How It Works
A retiree targets a 60/40 stock/bond allocation with $1,000,000:
| Start | After Bull Market | After Rebalancing | |
|---|---|---|---|
| Stocks | $600,000 (60%) | $750,000 (68%) | $660,000 (60%) |
| Bonds | $400,000 (40%) | $350,000 (32%) | $440,000 (40%) |
| Total | $1,000,000 | $1,100,000 | $1,100,000 |
Common approaches:
- Calendar rebalancing: Rebalance on a fixed schedule (annually, quarterly). Simple and effective.
- Threshold rebalancing: Rebalance when any asset class drifts more than 5% from target. Slightly more responsive to large market moves.
- Withdrawal rebalancing: Take retirement withdrawals from the over-weighted asset class. Tax-efficient and naturally restores balance.
The "rebalancing bonus" comes from the systematic discipline of buying low and selling high — the opposite of what emotional investors tend to do.
Why It Matters for Retirement Planning
Without rebalancing, a portfolio's risk profile changes over time in unpredictable ways:
- After a long bull market, a 60/40 portfolio might drift to 75/25 — far more equity risk than intended
- This increased equity exposure amplifies sequence-of-returns risk precisely when the portfolio is most vulnerable to a correction
- Conversely, after a bear market, the portfolio drifts toward bonds, potentially missing the recovery rally
For retirees, rebalancing using withdrawals is particularly powerful: take distributions from the over-weighted asset class, avoiding unnecessary trades and capital gains taxes while maintaining the target allocation.
A Practical Example
A 70-year-old retiree has a $900,000 portfolio targeting 50/50 stocks/bonds and withdraws $36,000/year. After a strong stock year:
- Stocks: $540,000 (60%) — up from 50% target
- Bonds: $360,000 (40%) — below 50% target
Instead of selling $45,000 in stocks and buying $45,000 in bonds, the retiree takes their entire $36,000 annual withdrawal from the stock allocation. The result:
- Stocks: $504,000 (53.6%) — closer to target
- Bonds: $360,000 (46.4%) — closer to target
This single action reduces equity over-weight without triggering taxable sales in the bond account. Combined with the next year's withdrawal from whichever asset is over-weight, the portfolio naturally stays near its 50/50 target.
Frequently Asked Questions
- How often should I rebalance my retirement portfolio?
- Annual or semi-annual rebalancing works well for most retirees. Calendar-based rebalancing (e.g., every January) is simple and effective. Threshold-based rebalancing (when any asset class drifts more than 5% from its target) can be slightly more efficient but requires monitoring. More frequent rebalancing adds transaction costs without meaningful improvement.
- Does rebalancing improve returns?
- Rebalancing primarily controls risk, not enhances returns. It does capture a small 'rebalancing bonus' by systematically buying low and selling high, but the main benefit is keeping your portfolio's risk level consistent with your plan. Without rebalancing, a portfolio naturally drifts toward higher equity exposure and higher risk over time.
- Can I rebalance using withdrawals instead of selling?
- Yes — this is the most tax-efficient approach for retirees. Instead of selling winners and buying losers (which can trigger capital gains), take your withdrawals from the over-weighted asset class. This naturally brings the portfolio back toward target without realizing taxable gains.