Table of Contents
Market gains and losses can gradually alter the makeup of your investment portfolio over time. As the value of different investments changes, your asset allocation may drift away from your original plan, potentially changing the level of risk you’re taking. That’s where portfolio rebalancing comes in.
Portfolio rebalancing generally involves buying and selling investments to bring your portfolio back in line with your target allocation. Some investors rebalance on a set schedule, such as once a year, while others make adjustments only when a particular asset class moves beyond certain predetermined limits.
While rebalancing can help keep your portfolio aligned with your financial goals, it isn’t always cost-free. Selling investments in a taxable account may trigger capital gains taxes and some transactions may involve fees or commissions. So how often should you rebalance? And if you invest in index funds or ETFs, is rebalancing already happening behind the scenes? Here’s what you need to know.
Key Points
• Portfolio rebalancing is the process of adjusting your investments to maintain your target asset allocation.
• Market fluctuations can cause your portfolio’s risk level to drift, making periodic rebalancing necessary to align with your financial goals.
• While index funds and ETFs provide broad market exposure, they do not automatically rebalance your overall portfolio’s asset mix.
• Investors can rebalance on a set calendar schedule or by using threshold-based methods when asset classes drift outside of desired ranges.
• Rebalancing helps manage risk and maintain discipline, though it is important to consider potential tax consequences and transaction costs before making trades.
What Is Portfolio Rebalancing?
Portfolio rebalancing is the process of adjusting your investments to maintain your desired asset allocation.
Asset allocation refers to how your portfolio is divided among investment categories such as stocks, bonds, cash, and alternative assets. Investors often choose a target allocation based on factors like their financial goals, investment timeline, and tolerance for risk.
For example, an investor might decide on a portfolio consisting of 60% stocks and 40% bonds. If stocks outperform bonds over time, that allocation could gradually shift to 70% stocks and 30% bonds. As a result, the portfolio may become riskier than originally intended. Rebalancing restores the target allocation by reducing positions that have grown beyond their target weight and increasing exposure to areas that have become underrepresented.
Portfolio rebalancing may involve trading stocks, but the goal is generally not to react to market fluctuations. Instead, rebalancing is generally used as a risk-management tool that helps keep a portfolio aligned with an investor’s long-term plan.
ETF vs. Index Fund: Which is Better for Rebalancing?
When building a portfolio, many investors use ETFs and index funds because they provide broad market exposure and built-in diversification. Both types of investments typically adjust their underlying holdings periodically on a regular basis with no action needed on the investor’s part. However, that doesn’t mean your overall portfolio is automatically rebalanced.
For example, an S&P 500 index fund may adjust its holdings when the composition of the index changes. Likewise, an ETF that tracks a specific benchmark will typically make similar adjustments. It’s important to keep in mind, though, that those changes occur within the fund itself.
If your portfolio includes multiple funds — such as a stock fund and a bond fund — you may still need to rebalance your overall asset allocation if one asset class becomes a larger or smaller portion of the portfolio than you intended.
Neither investing in ETFs nor investing in index funds is inherently better for portfolio rebalancing. Both can serve as effective tools within a diversified portfolio. The choice often comes down to factors such as:
• Expense ratios
• Trading flexibility
• Tax considerations
• Minimum investment requirements
• Account type
Regardless of which investment vehicle you choose, monitoring your overall allocation remains important.
Why You Should Consider Rebalancing Your Portfolio
Rebalancing can play an important role in maintaining a long-term investment strategy. Some key benefits include:
Helps Maintain Your Desired Risk Level
A primary reason why investors rebalance is to manage risk. Market gains or losses in one area of the portfolio can gradually increase or decrease exposure to a particular asset class. For example, if stocks experience strong growth over several years, they may represent a much larger percentage of your portfolio than originally intended. Rebalancing can help bring the allocation back in line with your target risk profile.
Supports Diversification
Diversification involves spreading investments across multiple asset classes, sectors, and geographic regions. Over time, the relative performance of your investments may shift, potentially causing the portfolio to become concentrated in fewer areas. Rebalancing can help restore diversification by preventing any single company, sector, or asset class from dominating your portfolio.
Encourages Discipline
Market volatility can make it tempting to make emotional investment decisions. A rebalancing strategy creates a structured process that focuses on maintaining your long-term plan rather than reacting to short-term movements in the market.
Creates Opportunities to Review Your Goals
Rebalancing can also serve as a reminder to periodically review your financial goals. As your circumstances change, you may decide that your target allocation should change as well. For example, someone nearing retirement may choose a different asset allocation than they used earlier in their career.
Recommended: Stock Market Basics for Beginners
Get up to $1,000 in stock when you fund a new Active Invest account.*
Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.
How Often Do You Need to Rebalance Your Portfolio?
There is no single rebalancing schedule that works for everyone. Some investors rebalance at regular intervals, such as quarterly, semiannually, or annually, an approach known as the calendar method.
Other investors use a threshold-based approach, rebalancing only when an allocation drifts beyond a specific range. For example, an investor targeting a 60% stock allocation might choose to rebalance whenever stocks rise above 65% or fall below 55% of the portfolio.
Both calendar- and threshold-based strategies can be effective ways to manage allocation drift. The right choice often depends on factors such as:
• Risk tolerance
• Portfolio size
• Tax considerations
• Trading costs
It’s also important to avoid excessive rebalancing. Making frequent trades can increase transaction costs and, in taxable accounts, potentially create tax consequences.
Many investors find that reviewing their portfolios once or twice a year strikes a reasonable balance between maintaining their allocation and minimizing unnecessary trading.
How to Rebalance Your Portfolio in 4 Steps
Some investors rely on financial advisors or robo advisors to monitor and rebalance their portfolios. If you manage your own investments, however, here is a simple process for rebalancing your portfolio:
1. Review your current allocation: Start by determining how your investments are currently divided among asset classes. Many online investing platforms provide portfolio-allocation tools that automatically calculate the percentage of your portfolio invested in stocks, bonds, cash, and other assets.
2. Compare it to your target allocation: Next, compare your current allocation to the target allocation you’ve established. Suppose your target is 60% stocks and 40% bonds. If your current allocation has drifted to 68% stocks and 32% bonds, you may decide that rebalancing is appropriate.
3. Determine how you’ll rebalance: There are several ways to rebalance a portfolio. One is to sell a portion of overweight investments and use the proceeds to purchase underweight assets. Another is to direct new contributions (or dividends and distributions) toward underrepresented asset classes.
4. Make any needed trades: Once you have a strategy, execute it by making any trades necessary to bring your portfolio back into balance. Depending on how much cash you have in your portfolio, you may need to sell overrepresented assets first to free up the cash needed to buy underrepresented ones.
Recommended: Guide to Tax-Loss Harvesting
Common Portfolio Rebalancing Strategies
Investors use a variety of approaches when rebalancing their portfolios.
Rebalancing for Diversification
This strategy focuses on maintaining exposure across multiple asset classes. For example, if U.S. stocks become a larger share of your portfolio over time, your allocation to other investments — such as bonds or international stocks — may represent a smaller percentage of your overall holdings.
Rebalancing for diversification involves adjusting those allocations so that no single area becomes disproportionately large. This approach can help maintain the level of diversification originally built into the portfolio.
Smart Beta and Strategic Rebalancing
Rather than simply track an index, smart beta funds follow rules-based strategies designed to emphasize specific predetermined factors such as value, quality, momentum, or low volatility. Typically, the fund manager handles the rebalancing within the fund. For example, a value-focused smart beta ETF may periodically adjust its holdings to maintain exposure to value stocks according to its methodology. The investor doesn’t need to take any action for that internal rebalancing.
However, inverters may still need to monitor and rebalance their overall portfolios if allocations across asset classes drift from their target levels.
Rebalancing Retirement Accounts
Retirement accounts such as 401(k)s and IRAs are often among the easiest places to rebalance because trades within these accounts generally do not trigger immediate capital gains taxes.
Many retirement plans allow participants to adjust allocations online with just a few clicks. Some plans also offer target-date funds, which automatically adjust their asset allocation as the target retirement year approaches.
Even if you use a target-date fund, it’s still a good idea to periodically review your overall investment portfolio — including taxable accounts — to ensure it aligns with your goals and risk tolerance.
The Takeaway
Portfolio rebalancing is the process of adjusting your investments to maintain your desired asset allocation. As markets rise and fall, your portfolio can gradually drift away from its original mix of stocks, bonds, and other assets, potentially changing your overall risk exposure.
By periodically reviewing your allocations — whether on a set schedule or when certain thresholds are met — and making any needed adjustments, you can stay disciplined, manage risk, and help ensure your investments continue to stay aligned with your financial goals.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest®. You can trade stocks, ETFs, or options through self-directed investing with SoFi Securities, or simply automate your investments with a robo advisor from SoFi Wealth. You'll gain access to alternative investments and upcoming IPOs, and can plan for retirement with a tax-advantaged IRA. With SoFi, you can manage all your investments, all in one place.
FAQ
What is the difference between an ETF and an index fund?
Both exchange-trade funds (ETFs) and index mutual funds can track a market index, such as the S&P 500, but they trade differently. ETFs trade on an exchange throughout the day like stocks, while index mutual funds are bought and sold at the fund’s net asset value (NAV), which is calculated after the market closes. ETFs may offer greater trading flexibility, while index funds may work well for long-term investors.
Should I use ETFs or index funds to rebalance my portfolio?
Either can work for rebalancing. The better choice depends on factors such as investment minimums, expense ratios, tax considerations, and how you prefer to invest. Regardless of whether you use ETFs, index mutual funds, or a combination of both, you’ll still need to monitor your overall asset allocation and make adjustments when it drifts from your target.
Does rebalancing my portfolio trigger capital gains taxes?
It can. If you sell investments for a profit in a taxable brokerage account while rebalancing, you may owe capital gains taxes on those gains. Rebalancing within tax-advantaged accounts such as IRAs and 401(k)s generally does not create immediate capital gains tax consequences. Tax rules can vary based on your situation, so consider consulting a tax professional if needed.
How often should a beginner rebalance their portfolio?
Many beginners find that reviewing and potentially rebalancing their portfolios once or twice a year is a manageable approach. Some investors also use allocation thresholds, such as rebalancing when an asset class moves more than five percentage points from its target allocation. The best schedule depends on your goals, risk tolerance, and investment strategy.
Is it better to rebalance manually or use an automated robo advisor?
Neither approach is universally better. Manual rebalancing gives you more control over when and how adjustments are made, but it requires ongoing monitoring. Robo advisors can automatically track and rebalance your portfolio based on predefined rules, which may appeal to investors seeking a more hands-off approach. The right choice depends on your preferences, costs, and comfort level managing investments.
About the author
Julia Califano
Julia Califano is an award-winning journalist who covers banking, small business, personal loans, student loans, and other money issues for SoFi. She has over 20 years of experience writing about personal finance and lifestyle topics. Read full bio.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
Mutual Funds (MFs): Investors should read and carefully consider the information contained in the prospectus, which contains the Mutual Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or SoFi's customer service at: 1.855.456.7634. Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risks. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may have tax implications.
Exchange Traded Funds (ETFs): Before investing in Exchange Traded Funds (ETF), always read the fund's prospectus. It contains important information about the fund’s objectives, risks, and fees. You can get a prospectus from the fund company’s website or by emailing our customer service at [email protected].
Options involve substantial risk of loss and the possibility an investor may lose the entire amount invested. Before starting options trading, investors should be familiar with the Characteristics and Risks of Standardized Options . TTax implications with options should be considered. Consult your tax advisor to understand any impacts to your taxes.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Investment Risk: Diversification can help reduce some investment risk, but cannot guarantee profit nor fully protect in a down market.
SOIN-Q226-027