Asset allocation and rebalancing: how to maintain your portfolio

The decision that most shapes your portfolio's behaviour is not which fund you pick, but how much you put in each asset class: stocks, bonds and cash. That mix is your asset allocation. Over time, markets knock it out of shape, and rebalancing puts it back.

Asset allocation determines most of a portfolio's risk and return.
When stocks rise, their weight grows and the portfolio becomes riskier than you chose.
Rebalancing means selling what has risen most and buying what has lagged, or directing new contributions.
Two methods: by calendar (once a year) or by bands (when an asset drifts 5 points).
With new contributions or tax-advantaged accounts you can rebalance without paying tax.

Choosing an allocation

It depends mainly on your horizon and how big a fall you can take without selling. As a rough starting point:

How a portfolio drifts

You start with $100,000: 60,000 in stocks and 40,000 in bonds (60/40). In one year stocks rise 30% and bonds 2%:

Stocks: $78,000.
Bonds: $40,800.
Total: $118,800, with 65.7% in stocks.

Without doing anything, your portfolio is riskier than the one you chose. To return to 60/40, stocks should be $71,280: you would move about $6,720 from stocks to bonds.

When to rebalance

By calendar: once a year, on a fixed date. Simple and avoids emotional decisions.
By bands: only when an asset drifts beyond a threshold, for example 5 points (in the example, above 65%). Avoids unnecessary trades.
Combined: review once a year and act only if drift exceeds the band.

Rebalancing too often adds costs without improving results.

How to do it while paying less tax

With contributions: direct new money to the asset that has fallen below target. Nothing is sold.
Inside tax-advantaged accounts: in retirement accounts, trades usually do not trigger tax.
With fund switches: in some countries, such as Spain, switching between mutual funds is not taxed.
By selling: in taxable accounts, selling at a gain is taxed. Weigh whether the drift justifies the tax.

Why it works

Rebalancing does not aim to maximise returns but to keep the risk you chose. As a side effect, it forces you to sell high and buy low in a disciplined way — the opposite of what fear and euphoria push us to do. See panic selling.

Frequently asked questions

What does rebalancing a portfolio mean?

Returning each asset class to its target weight after market moves have shifted it, by selling what is overweight or directing contributions to what is underweight.

How often should I rebalance?

Once a year is usually enough, or when an asset drifts more than about 5 points from its target.

Is rebalancing taxed?

Selling at a gain in a taxable account is. Using new contributions, tax-advantaged accounts or tax-free fund switches avoids it.

Which asset allocation suits me?

It depends on your horizon and risk tolerance. The closer the goal or the less you tolerate falls, the more bonds and cash.