Keep Your Risk Where You Chose to Put It
To rebalance an ETF portfolio, you sell some of whatever has grown above its target and buy more of whatever has fallen below, bringing the mix back to the percentages you chose. Most investors do it once a year, or whenever a fund drifts about five percentage points from its target.
It sounds like a small housekeeping job, but it decides how much risk you are really taking. Left alone, a portfolio slowly turns into a different investment from the one you built, and most investors never notice until a crash shows them.
This guide shows you, with real return data from 2012 to 2025, how fast portfolios drift, how five different rebalancing strategies compared, how to rebalance without selling anything, and how to avoid the tax mistakes that catch many investors out.
Start Here: Learn to Manage a Portfolio Properly
Financial Regulation Courses (FRC) is a financial education provider with its roots in regulation and professional training. FRC sells no investments, manages no money and earns no commission on any fund, so its courses teach you how to manage a portfolio without steering you towards any product.
ETF Investing for Beginners teaches you how ETFs work and how to build your first portfolio. ETF Investing Strategies teaches you to plan, build and manage a complete ETF portfolio, and Advanced ETF Investing covers rebalancing, tax placement, risk and complex funds in depth.
FRC’s programs and memberships are open to everyone. Each course can be taken on its own, and interest-free payment plans let you spread the cost over two, three or four months.
How FRC’s Courses Teach Rebalancing
Rebalancing only makes sense once you understand what you are balancing. ETF Investing for Beginners starts with the foundations, from ETF basics to costs, trading, risk and building a first portfolio, and ETF Investing Strategies then shows you how to set an asset allocation and manage it over time.
Advanced ETF Investing takes you into the decisions that matter most as a portfolio grows: when to rebalance, which accounts to do it in and how to keep tax costs down. These are the details most self-taught investors learn only after making an expensive mistake.
Every chapter ends with a 15-question assessment with an 80% pass mark, and the next chapter only unlocks once you pass. FRC uses AI teachers to present its video lessons in the FRC dictionary, so every lesson is delivered to the same high standard, every time, instead of depending on whichever instructor happens to be teaching, and every lesson is reviewed by qualified finance and compliance professionals before it is published.
What Rebalancing Means
Every portfolio starts with a target mix, such as 60% stocks and 40% bonds. That mix is a decision about risk: how much growth you want, and how large a fall you can live with.
Markets do not respect that decision. When stocks rise faster than bonds, the stock share grows, and the portfolio takes on more risk than you chose. When stocks fall, the opposite happens.
Portfolio rebalancing is simply the act of putting the mix back. It forces you to trim what has done well and add to what has lagged, which is the discipline of buying low and selling high built into your routine.
How Fast a Portfolio Drifts
To show how quickly drift builds up, FRC took a 60% total US stock market (VTI) and 40% US bond (BND) portfolio at the start of 2012 and never touched it. The table shows its stock share at the end of each year.
| End of year | Stock share | End of year | Stock share |
|---|---|---|---|
| 2012 | 62.7% | 2019 | 78.1% |
| 2013 | 69.6% | 2020 | 80.1% |
| 2014 | 70.9% | 2021 | 83.8% |
| 2015 | 70.9% | 2022 | 82.7% |
| 2016 | 72.8% | 2023 | 85.1% |
| 2017 | 75.8% | 2024 | 87.5% |
| 2018 | 74.9% | 2025 | 88.4% |
Within two years, the portfolio was already close to 70% stocks. By 2020 it had passed 80%, and by the end of 2025 it held about 88% stocks and only 12% bonds.
The investor who chose a balanced 60/40 portfolio in 2012 ended up owning something close to an all-stock portfolio. Nothing dramatic caused it, just ordinary years in which stocks rose faster than bonds.
Five Rebalancing Strategies Compared
FRC then tested five ways of managing the same $10,000, 60/40 portfolio from 2012 to 2025, using actual annual returns.
| Strategy | $10,000 became | Worst year | Highest stock share reached | Number of rebalances |
|---|---|---|---|---|
| Rebalance every year | about $36,300 | −16.9% | 67.2% | 14 |
| Rebalance every two years | about $36,900 | −16.9% | 69.6% | 7 |
| Rebalance every three years | about $37,200 | −17.3% | 70.9% | 4 |
| Rebalance when stocks drift 5 points from target | about $36,900 | −16.9% | 69.6% | 5 |
| Never rebalance | about $45,300 | −18.5% | 88.4% | 0 |
The highest stock share is measured at each year end, before any rebalance. The figures are before taxes and trading costs.
Three Lessons From the Test
The first lesson is that the four rebalancing strategies ended within about $1,000 of each other. How often you rebalance matters far less than whether you rebalance at all.
The second is that the threshold strategy matched the results of rebalancing every year with only five trades instead of fourteen. Fewer trades mean fewer chances of triggering tax and less work for you.
The third lesson is the most important. The never-rebalanced portfolio made the most money, but only because US stocks had an exceptional run, and it did so by quietly turning into a much riskier portfolio with a worse worst year.
Had the period ended with a long bear market instead, the investor holding 88% stocks would have suffered losses far larger than they ever signed up for. Rebalancing is not designed to maximize return. It is designed to keep your risk where you chose to put it.
Rebalancing Without Selling Anything
The simplest way to rebalance is to use new money. Instead of selling, you direct each new contribution to whichever fund is below its target.
FRC modeled $6,000 a year, the equivalent of $500 a month, invested from 2012 to 2025 in a 60/40 portfolio, managed three different ways.
| Method | Value at end of 2025 | Stock share at end | Highest stock share reached |
|---|---|---|---|
| Split contributions 60/40 and rebalance every year | about $175,500 | 60.0% | 67.2% |
| Direct all new money to whichever fund is underweight, never sell | about $176,200 | 65.3% | 67.2% |
| Split contributions 60/40 and never rebalance | about $194,700 | 80.2% | 80.2% |
Directing new money kept the stock share almost exactly where annual rebalancing kept it, without a single sale. For anyone still adding money regularly, it is the cleanest way to stay on target, and it creates no tax bill at all.
How to Rebalance, Step by Step
Start by checking your current mix. Add up the value of every fund across all your accounts and work out what percentage each one represents.
Next, compare each fund with its target. If your target is 60% stocks and you now hold 70%, you are ten percentage points overweight in stocks.
Then decide how to correct it. If you are still investing regularly, send new money to the underweight fund first, and only sell if the gap is too large to close that way.
Finally, place any sales in the right account. Wherever possible, sell inside a tax-advantaged account such as a 401(k) or IRA, where trades do not trigger capital gains tax.
A Worked Example
Imagine a $100,000 portfolio with a target of 60% stocks and 40% bonds. After a strong year it holds $70,000 in a stock ETF and $30,000 in a bond ETF.
| Fund | Target | Value now | Target value | Action |
|---|---|---|---|---|
| Stock ETF | 60% | $70,000 | $60,000 | Sell $10,000 |
| Bond ETF | 40% | $30,000 | $40,000 | Buy $10,000 |
| Total | 100% | $100,000 | $100,000 |
One sale and one purchase bring the portfolio back on target. If the investor were adding $1,000 a month instead, putting the full amount into the bond ETF would close the gap in about a year and a half, without selling anything.
Calendar or Threshold?
Calendar rebalancing means checking and resetting on a fixed date, such as every January or on your birthday. It is easy to remember and easy to stick to.
Threshold rebalancing means acting only when a fund drifts a set distance from its target, commonly five percentage points. Some investors use a version known as the 5/25 rule, rebalancing when a large holding moves five percentage points or a small holding moves by a quarter of its target weight.
Many investors combine the two, checking once or twice a year but only trading if a threshold has been crossed. In FRC’s test, that approach delivered the same protection with far fewer trades.
Taxes and Costs
In a taxable brokerage account, selling a fund that has risen in value can trigger capital gains tax. On a large portfolio that has grown for years, that tax can be significant, so where you rebalance matters as much as when.
Rebalancing inside a 401(k) or IRA avoids that problem, because trades inside those accounts are not taxed. Many investors hold the same mix across several accounts and make all their adjustments in the tax-advantaged ones.
If you sell a fund at a loss and buy the same or a substantially identical fund within 30 days before or after the sale, the wash sale rule can cancel the tax benefit of that loss. FRC’s guide to how to minimize capital gains tax explains the wider tax picture.
Trading costs are now small for most ETF investors, as many brokers charge no commission. The bid-ask spread still applies, so using limit orders and trading during normal market hours keeps costs down.
Rebalancing Through a Crash
Rebalancing is hardest exactly when it does the most good. At the end of 2022, after US stocks had fallen 19.5%, rebalancing meant selling bonds and buying more stocks at depressed prices.
It felt wrong to many investors at the time. Yet the total US stock market gained 26.1% in 2023, and those who had topped up their stocks at the end of 2022 captured more of that recovery.
This is why rebalancing works best as a rule you set in advance, not a decision you make in the moment. Investors who understand why they rebalance are far more likely to follow through when the news is at its worst.
The Cost of Drift Near Retirement
Drift is most dangerous in the years just before you need the money. A large fall at that point leaves little time to recover, and it can force you to sell investments at low prices to cover living costs.
To show the scale of the risk, FRC applied the 2008 financial crisis returns, about −37.0% for the total US stock market and +6.9% for US bonds, to a $500,000 portfolio held two different ways.
| Portfolio on $500,000 | Return in a 2008-style year | Loss in dollars |
|---|---|---|
| Rebalanced, 60% stocks and 40% bonds | about −19.5% | about $97,300 |
| Never rebalanced, drifted to about 88% stocks | about −31.9% | about $159,600 |
The drifted portfolio would have lost about $62,300 more in a single year. Its owner believed they held a balanced 60/40 portfolio, but drift had quietly given them almost all the risk of an all-stock one.
This is why many investors review their mix more carefully in the five to ten years before retirement. Rebalancing in those years locks in the gains of a strong market and makes sure a crash cannot do more damage than the plan allows.
Signs It Is Time to Rebalance
| Sign | What to do |
|---|---|
| A fund is five or more percentage points from its target | Rebalance, starting with new contributions |
| Your rebalancing date has arrived | Check the mix and trade only if needed |
| Your goals or time horizon have changed | Set a new target first, then rebalance to it |
| You are close to retirement and stocks have grown large | Rebalance to lock in a safer mix before you need the money |
| A crash has pushed stocks well below target | Rebalance by buying stocks, even though it feels uncomfortable |
Common Rebalancing Mistakes
The most common mistake is never doing it at all, as the drift table shows. The second is doing it too often, trading every small movement and creating unnecessary tax and effort.
The third is rebalancing in a taxable account when the same adjustment could be made tax-free inside a 401(k) or IRA. The fourth is abandoning the plan during a crash, selling stocks instead of buying them.
The last is rebalancing a portfolio full of overlapping funds. Keeping the number of funds small makes every rebalance simpler, which is one reason the three-fund portfolio is so popular.
Questions People Ask
How often should I rebalance my ETF portfolio? Once a year is enough for most investors. In FRC’s test, rebalancing every year, every two years, every three years or at a five-point threshold all produced similar results, so consistency matters more than frequency.
What is the 5% rebalancing rule? It means rebalancing whenever a fund moves five percentage points away from its target. A 60% stock target would be rebalanced once stocks reached 65% or fell to 55%.
What is the 5/25 rule? It is a threshold method that rebalances when a large holding moves five percentage points from target, or when a smaller holding moves by a quarter of its target weight.
Does rebalancing increase returns? Not necessarily. Its main purpose is to control risk, and in a long rising market an unrebalanced portfolio can earn more, while taking on far more risk.
Should I rebalance in a down market? Yes, if your plan calls for it. Rebalancing after a fall means buying stocks at lower prices, which helped investors who did it at the end of 2022.
Is rebalancing taxable? It can be in a taxable account, because selling a fund at a gain can trigger capital gains tax. Rebalancing inside a 401(k) or IRA, or by directing new contributions, avoids that.
Can I rebalance without selling? Yes. Directing new contributions to whichever fund is below target keeps the portfolio on track without any sales, as FRC’s contribution test shows.
Do target-date funds rebalance automatically? Yes. All-in-one and target-date funds rebalance internally, which is one reason some investors choose them, though you give up control over the exact mix.
Should I rebalance my 401(k)? Yes. Many 401(k) plans offer an automatic rebalancing option that resets your mix on a set schedule, and because trades inside a 401(k) are not taxed, it is often the best account to make your adjustments in.
What is the best time of year to rebalance? There is no best month. What matters is choosing a date you will remember, such as the start of the year or your birthday, and sticking to it every year.
What is the 70/30 rule in rebalancing? It refers to a portfolio target of 70% stocks and 30% bonds. Rebalancing keeps the portfolio close to that mix as markets move.
The Bottom Line
Rebalancing keeps your portfolio’s risk where you chose to put it. Left alone, a 60/40 portfolio from 2012 drifted to about 88% stocks by 2025, while every rebalancing strategy tested kept it close to target with similar results.
Pick a simple rule, use new money first, rebalance inside tax-advantaged accounts and stick to the plan when markets fall. Learn to manage a portfolio with that discipline through ETF Investing for Beginners, ETF Investing Strategies and Advanced ETF Investing.
