How to Rebalance Your Portfolio (Simple 3-Step Guide)
“Buy Low, Sell High” is the oldest rule in investing, yet most people fail to do it. Rebalancing forces you to do it mechanically, ensuring your risk never exceeds your comfort zone.
Why Doing Nothing is Dangerous
Imagine you started with a safe 60/40 split (60% Stocks, 40% Bonds). After a bull market, stocks grow faster than bonds.
| Asset Class | Original Target | After 5 Years (No Action) |
|---|---|---|
| Stocks (High Risk) | 60% | 80% (Drifted) |
| Bonds (Safe) | 40% | 20% (Shrunk) |
| Risk Profile | Balanced | Aggressive |
| Method | Tax Impact |
|---|---|
| Sell & Buy | Capital Gains |
| New Cash | $0 Tax |
How to Execute a Rebalance
You don’t need to do this daily. Once a year (e.g., your birthday) is sufficient.
Step 1: Check Your Allocation
Log in and compare your Current % vs. Target %.
Example: Stocks are at 70%, but you want them at 60%. You are +10% overweight.
Step 2: The “New Cash” Trick (Tax-Smart)
Before you sell anything, try to fix the balance by adding new money.
Instead of selling the expensive stocks (which triggers tax), simply use your monthly deposit to buy only Bonds (the underweight asset) until the percentages align.
Step 3: Sell Winners (If Necessary)
If you don’t have new cash to add, you must sell the overweight asset.
• Sell: 10% of Stocks.
• Buy: Bonds with the proceeds.
Congratulations! You just sold high and bought low.
Time vs. Threshold
There are two schools of thought on when to pull the trigger.
- Time-Based (Easiest): Do it once a year on a specific date. Simple, low maintenance.
- Threshold-Based (Optimal): Do it only when an asset drifts by more than 5% (e.g., 60% → 65%). This captures market swings better but requires monitoring.