Finance Explained Simply
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Intermediate5 min read

What is portfolio rebalancing and why do it?

By the FES team · Published 22 March 2026

In brief: Portfolio rebalancing is the process of returning your investment mix back to its original target allocation after markets have shifted it. Without rebalancing, a strong run in equities can gradually turn a moderate investor into an aggressive one — without any conscious decision being made.

How drift happens

Say you start with 70% equities and 30% bonds. After a strong year for stocks, your portfolio might naturally drift to 80/20. You haven't done anything wrong — markets moved. But now your risk profile has changed: you own more of the riskier asset class, so a market downturn will hit you harder than you originally planned for.

Portfolio Drift: Target vs Actual Target (Year 0) Equities 70% Bonds 30% After Drift Equities 80% Bonds only 20%! Rebalanced 70% 30%

The mechanics: how to rebalance

Rebalancing involves selling assets that have grown above their target weight and buying those that have fallen below. For example, to move from 80/20 back to 70/30, you sell some equities and buy bonds. In practice, many investors rebalance by directing new contributions into underweight assets rather than selling, which avoids triggering taxable capital gains.

Annual
Most common rebalancing frequency
±5%
Typical rebalancing trigger threshold

The hidden benefit: systematic buy-low, sell-high

Rebalancing forces you to sell what has risen (and become expensive) and buy what has fallen (and become cheap) — a form of systematic counter-cyclical investing. Over full market cycles, rebalancing has been shown to modestly improve risk-adjusted returns compared to drifting portfolios, even though it may lag pure buy-and-hold in strong, one-directional bull markets.

When not to over-rebalance

Frequent rebalancing in a taxable account generates transaction costs and capital gains taxes that can erode the benefit. Most financial planners recommend rebalancing once or twice a year, or whenever an asset class drifts more than 5 percentage points from its target. In tax-advantaged accounts (ISA, SIPP in the UK; 401k, IRA in the US), rebalance more freely.

"Rebalancing is the only strategy that forces you to buy low and sell high automatically — without requiring any market timing skill."

What this means for you

If you invest in a mix of assets, set a target allocation, write it down, and review it once a year. If any category has drifted more than 5%, bring it back. This single habit — consistently applied — will prevent your portfolio from quietly becoming riskier than you intended, particularly in extended bull markets where equities can dominate if left unchecked.

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