Portfolio rebalancing is the process of realigning your portfolio back to your target asset allocation. It’s one of the most important but overlooked investing disciplines.
Why Rebalance?
Without rebalancing, your portfolio drifts over time:
| Asset | Target | Year 1 | Year 3 | Year 5 |
|---|---|---|---|---|
| Stocks | 60% | 65% | 75% | 82% |
| Bonds | 40% | 35% | 25% | 18% |
After 5 years of strong stock returns, you’re 82/18 instead of 60/40. You now have much higher risk than intended.
Benefits of Rebalancing
| Benefit | Explanation |
|---|---|
| Maintains risk level | Keeps risk where you want it |
| Forces discipline | Buy low, sell high automatically |
| Removes emotion | Systematic, not emotional |
| Improves returns | Can boost long-term returns |
When to Rebalance
| Method | How It Works | Best For |
|---|---|---|
| Calendar rebalancing | Fixed schedule (e.g. annual) | Simple, low effort |
| Threshold rebalancing | When allocation drifts 5%+ | More precise |
| Combined | Annual review + threshold triggers | Most practical |
Annual rebalancing is the sweet spot for most investors. Quarterly creates too many trades and taxes. Every 2+ years allows too much drift.
How to Rebalance
Method 1: Sell and Buy
- Sell overperforming assets
- Use proceeds to buy underperforming assets
| Step | Example |
|---|---|
| Current stocks | 70% (target 60%) |
| Current bonds | 30% (target 40%) |
| Sell 10% of stocks | £10,000 |
| Buy £10,000 of bonds | Bonds now 40% |
Downside: May trigger Capital Gains Tax outside an ISA.
Method 2: New Contributions
Use new money to buy underweight assets.
| Scenario | Action |
|---|---|
| Stocks at 65% (target 60%) | All new contributions go to bonds |
| Continue until stocks back to 60% | Then resume normal contributions |
Upside: No selling, no tax implications.
Method 3: Dividend Redirect
Redirect dividends from overweight assets to underweight assets.
Example: Annual Rebalance
| Portfolio | Target | Current | Drift | Action |
|---|---|---|---|---|
| UK stocks | 25% | 30% | +5% | Sell £5,000 |
| Global stocks | 25% | 28% | +3% | Hold |
| Bonds | 30% | 22% | -8% | Buy £8,000 |
| Cash | 20% | 20% | 0% | Hold |
Sell £5,000 of UK stocks, buy £5,000 of bonds (use the remaining £3K from bonds rebalance via new contributions or cash).
Rebalancing Frequency
| Frequency | Pros | Cons |
|---|---|---|
| Monthly | Very tight control | Too many trades, high costs |
| Quarterly | Good control | Moderate trading |
| Annually | Low cost, good enough | Can miss large drifts |
| Threshold (5%) | Captures extremes | Less predictable |
Costs to Consider
| Cost | Impact |
|---|---|
| Trading fees | £5-£10 per trade |
| Spread | Bid/ask on ETF trades |
| Capital Gains Tax | Outside ISA/SIPP |
| Time | 30 minutes annually |
Inside an ISA, rebalancing costs are minimal.
Common Mistakes
| Mistake | Fix |
|---|---|
| Rebalancing too often | Annual is sufficient |
| Letting fear stop you | ”Buy low” is uncomfortable but necessary |
| Ignoring tax implications | Rebalance inside ISAs first |
| Chasing performance | Don’t let winners run too far |
Bottom Line
Rebalancing is boring but essential. It keeps your risk level consistent and forces you to buy low and sell high. Review your portfolio annually, set 5% drift thresholds, and use new contributions to rebalance when possible. Inside an ISA, don’t overthink it — just do it.