Rebalancing

Rebalancing sells portions of asset classes that have risen above their target allocation and buys classes that have fallen below. The process forces sell-high and buy-low behavior, smoothing portfolio volatility and maintaining the investor’s chosen risk level. Common triggers are calendar-based (quarterly or annually) or tolerance-based (rebalance when any asset class drifts more than 5% from target). In taxable accounts, rebalancing creates capital gains, so new contributions and dividend reinvestment should be directed toward underweight asset classes first.

Example: a target 70% stocks / 30% bonds becomes 78% / 22% after a strong year. Rebalancing sells 8 percentage points of stock and buys 8 of bond. On a $2 million portfolio, that is $160,000 of sales. In a taxable account, prioritizing tax-lot selection to sell lots at or near long-term status limits the tax drag.

Common mistake: rebalancing each individual holding back to target, creating hundreds of small transactions and excessive capital gains. Rebalance at the asset-class level.

Rebalancing matters annually, after major market moves, and especially after IPO lockup expiration when employer stock suddenly constitutes a large weight of the portfolio.