How Do I Rebalance My Investment Accounts?

One of the most common mistakes we see with folks who have been managing their own investments is the lack of disciplined, periodic portfolio rebalancing after they’ve made strong initial investment choices.

Not rebalancing accounts can have different consequences at different life stages. For example, for most folks, a lack of regular rebalancing is far more likely to create a potentially problematic situation, like excessive risk exposure, in or near retirement than it is during the early accumulation years of portfolio building. Still, no matter your age or life stage, rebalancing is a critical part of portfolio management that a DIY investor should prioritize learning how to do. 

A great reason to start doing basic, routine rebalancing when you’re young is actually that it’s fairly simple to learn, which can set you up to grow with your accounts and learn more as your rebalancing needs become increasingly complex. (You can peek at the end of the article for examples of when this will start to happen.)

What is Rebalancing and Why Is It Important?

The concept of rebalancing is fairly simple. When you first design your own investment portfolio, you choose a certain percentage to go to different funds representing different asset classes. For example, an investor may have done some research on their situation and determined the portfolio that best matched their timeline and investing goals was:

  • 40% U.S. Large Cap Stock Fund
  • 10% U.S. Small Cap Stock Fund
  • 15% International Stock Fund
  • 35% Aggregate Bond Fund

Note that this isn’t a recommendation for a portfolio for you, as everyone’s portfolio composition should be built around their own risk tolerance and time horizon. It’s just an example to show how rebalancing works.

After a year passes, this initial allocation will have changed depending on how each of those asset classes performed. In a non-volatile year, the change may be small, but in a year of a lot of volatility, or over many years, the change can actually be pretty drastic. For example, after a year the non-rebalanced portfolio might look like: 

  • 42% U.S. Large Cap Stock Fund
  • 11% U.S. Small Cap Stock Fund
  • 13% International Stock Fund
  • 34% Aggregate Bond Fund

But after 20 years, the never rebalanced portfolio might look like:

  • 59% U.S. Large Cap Stock Fund
  • 14% U.S. Small Cap Stock Fund
  • 18% International Stock Fund
  • 9% Aggregate Bond Fund

The portfolio that started moderately aggressive at 65% stocks and 35% bonds, has now turned into an extremely aggressive 91% stock and 9% bond portfolio, simply because it’s never been rebalanced.

Think of a well-researched and planned out garden left to its own devices for 20 years. Nothing ever removed, nothing ever replanted. Certain things have grown better than others, certain things went to seed more successfully, and at the end of the day, a few varieties of plants have taken over, while others have died out completely. The same thing is happening with a portfolio that doesn’t get rebalanced.

In addition to making sure the asset classes stay close to what was intended, rebalancing is also a good way to get in the habit of selling off a little of what’s done well to buy a little of what’s done poorly at a regular and periodic interval, something that can be really hard to convince ourselves to do from a behavioral standpoint if we don’t have a disciplined process for it. Periodic rebalancing is a way to take our problematic emotions out of our investment decisions. It tells us when and how much to buy and sell, and if we stick to the process, it keeps us in a sell high, buy low pattern.

How to Create a Tool for Rebalancing

The easiest way to make sure routine rebalancing gets done is to do it on a regular schedule and to have the tools in place to do it when the time comes. I typically recommend a simple spreadsheet like this one (in this case, set up to match our example model portfolio from the previous section.)

Download the spreadsheet

You’ll want to build one to match your asset allocation, that will take your existing balances which you’d enter into the green cells in column C, and compare them to the desired percentages, and tell you how much to buy or sell in the yellow cells in column F.

The way this spreadsheet is set up, a number in parentheses in column F means to sell that much, while a number without parentheses in column F indicates that you need to buy that much.

While you could certainly use this template as a starting point and input your own asset allocation and percentages into it, I really recommend using this spreadsheet to acquaint yourself with the math and the process of how to rebalance, then building your own spreadsheet from scratch so that you understand the formulas and how they are working. A spreadsheet is only as good as the data its users input into it, and if you make your own and understand how it’s supposed to work, you’ll understand better what it’s trying to do, how to use it, and how to spot potential mistakes if there’s been a problem with a formula or data input.

How Often Should You Rebalance?

For a DIY Investor, we recommend a minimum of once per year. Typically, professionals rebalance client portfolios 2-4 times per year, sometimes at set times during the year, and sometimes after a set amount of market fluctuation has occurred. But establishing a routine around rebalancing at least once per year, at the same time each year, is a good place to start. Aim to meet that goal first and then expand upon it when you’re ready. A plan to rebalance 4 times per year may sound great, but if you don’t actually stick to the routine of doing it because it’s too cumbersome to adhere to, it’s not actually a great plan. We love reasonable, achievable goals, and if you have a portfolio that hasn’t been rebalanced in five or ten years, a once per year rebalancing will be a huge improvement over your current situation.  

Also, any time you make contributions, it’s important to run them through the rebalance spreadsheet so you know where they should be invested in your portfolio. (In the sample spreadsheet these new, uninvested contributions would be entered in under “cash.”) So, if you have a regular contribution schedule to your investment accounts, like monthly, quarterly, or annually, it makes sense to just run them through a quick rebalance at the same time that you contribute funds.

Consider Tax Consequences

For some types of accounts, like traditional or rollover IRAs, Roth IRAs, or 401ks, you don’t have to worry about the tax consequences of rebalancing because distributions, not trades, are what trigger a taxable event.

But for taxable individual or jointly owned brokerage accounts, every time you sell a position that you own, you’ll be incurring some sort of capital gain or loss, which will come with a potential tax consequence. How to deal with tax consequences of sales in taxable brokerage accounts (and what they’ll potentially cost you), is outside of the scope of this post, but it’s worth noting that if you’re doing your own investing in a taxable brokerage account, this is something you’ll want to research and be prepared for before you rebalance.

Can you Buy and Sell at the Same Time?

Depending on the trading platform and types of funds you use, it’s important to realize that rebalancing may take more than a day to complete. For example, if you’re using mutual funds rather than Exchange Traded Funds (ETFs), on some platforms you may need to sell one day and come back and make any purchases the next trading day.

For an investor who is using solely ETFs, you may be able to put the sell orders through and then, a few minutes later, go in and make the buy orders. It really depends on the types of funds you are using, and any restrictions or settlement periods the custodian (like Schwab, Vanguard, or Fidelity) may put on sell orders.

Is There Anything Else to Consider Before Rebalancing?

Besides tax consequences, the other big thing to consider before rebalancing is – do your asset allocation and the investments you’ve chosen still line up with your timeline and risk profile for the account?

Most likely, this isn’t going to change every year when you’re investing for something like retirement that’s many years away. However, as the goal you’re investing for gets closer, it often makes sense to adjust your asset allocation and strategy accordingly. It’s a good idea to consider this BEFORE you rebalance.

Additionally, we also recommend a quick check of the funds you are using to build your portfolio. Even though we use low-cost index funds that shouldn’t change much in terms of strategy each year, we still review all of our funds before we rebalance to make sure something hasn’t changed that would no longer make them a good fit for our client’s portfolios.

What if I’m Using a Blended Fund, a Target Date Fund, or a Robo Advisor?

Typically, these types of investments/strategies are designed to rebalance for you, so in general, you won’t need to do the same type of spreadsheet work as someone who is blending their own portfolio. However, at least once per year, it’s still important to get into your account and ask three questions.

⏱️

Are my investment goals and time-horizon the same as when I chose this fund? If not, it may be time to choose a new fund or strategy.

🏆

Is this fund still a good choice to meet those goals (has its strategy, expense ratio, or overall rating changed?)

💵

Do I have any uninvested cash that I need to get invested?

Don’t sleep on item 3. We can’t tell you how many accounts we’ve seen where people come in with really good investment choices in a DIY account and a lot of uninvested cash because they made an initial investment choice and assumed their ongoing contributions were being put into it when they were actually just sitting there in cash waiting to be invested. It’s imperative that you check this at least once per year to make sure your investments are not actually just sitting in a money market fund waiting for you to invest them.

Considering More Advanced Objectives – How Rebalancing Gets More Complex as We Get Closer to Goal Ages

As we age, three things happen that make rebalancing more complex.

The first is, we’ve often accumulated investment assets in a lot of different types of accounts. Many of these accounts may have different overall strategies – for example, depending on the taxation profile of the account (Roth, Traditional Tax Deferred, or Taxable Brokerage) we may have different strategies and asset allocations for each type of account. But we also need to be thinking about how all of our accounts overall represent the desired asset allocation we’re trying to achieve for our investment profile. So, we really need to start considering both the allocation goals for our individual accounts, how we’re using them to meet different income and tax objectives, AND allocation goals for all of our accounts considered together.

Second, as we are approaching retirement, it becomes important to consider the question – which accounts will I be pulling from in early retirement (which may need a big strategy adjustment to decrease their risk), and which ones will I not be accessing until later retirement (which may need to stay more growth-oriented)? These decisions should be informed by your overall tax and retirement income strategies, but they’ll definitely influence how you rebalance and adjust your asset allocation.

Finally, nearing and into retirement is often a time when tax consequences really come into play during rebalancing, because as you look to make your portfolio profile match a shorter time-horizon, this may involve needing to sell some highly appreciated positions, and where and how you do that will have a big impact on your taxes. Not surprisingly, this is often a time when DIY investors turn to professionals for support with navigating their investment, distribution, and tax strategies.

Rebalancing often gets overlooked by new or DIY investors even if they’ve been thoughtful about their initial investment choices, but it’s an important part of good portfolio hygiene, and one that becomes both increasingly important and increasingly complex as you approach retirement. So, with any luck, if you’ve left your portfolios to “do their own thing” for the last five, ten, or twenty years, this post will motivate you to move forward with a rebalance today, and at regular intervals in the future. Happy spreadsheeting!