Rebalancing is the routine maintenance that keeps a portfolio on course. Without it, the asset class that performs best gradually dominates your holdings, concentrating risk in precisely the area where you least want it. A portfolio that started as 60 per cent equities and 40 per cent bonds can drift to 75/25 after a strong equity run — exposing you to far more downside than you originally intended. Rebalancing restores the allocation you actually chose, and in doing so forces you to systematically sell what has become expensive and buy what has become cheap.
The challenge is that most rebalancing methods involve selling, and selling in a taxable account triggers capital gains tax. The best rebalancing strategy is therefore one that keeps your allocation on target while touching your holdings as little as possible.
Rebalancing without selling
The cheapest rebalance is one that never involves a disposal. Three methods achieve this.
New contributions. When you invest fresh money, direct it entirely at the underweight asset class until your allocation returns to target. If your portfolio has drifted to 65 per cent equities and 35 per cent bonds against a 60/40 target, sending your next £10,000 contribution entirely into bonds brings you back within a percentage point of target — with zero trades and zero tax. Repeated annually, this approach can keep a portfolio balanced indefinitely without ever selling a holding.
Dividend and distribution redirection. If your overweight asset class pays income — equity ETF distributions, bond coupon payments, or interest — redirect that cash to the underweight asset instead of reinvesting it where it falls. A 2 per cent yield on a £50,000 equity position moves £1,000 a year into bonds. Over several years, quietly redirected income rebalances thousands of pounds’ worth of drift without a single sell order.
Withdrawal rebalancing. If you are drawing down your portfolio for living expenses, sell from the overweight asset class first. You need the cash regardless, so using the sale to simultaneously trim an oversized position is the most natural and cost-free form of rebalancing available.
When to act: bands versus calendars
Once you have decided how to rebalance, the next question is when. Two schools of thought exist, and they trade simplicity against responsiveness.
Calendar rebalancing means picking a fixed date — typically once a year — and restoring your allocation to target on that date regardless of what has happened in between. It is simple, requires almost no monitoring, and works well for investors with stable, straightforward portfolios. The drawback is that it can allow significant drift for months at a time. If equities surge in January and your annual rebalance is in December, you spend eleven months with a riskier portfolio than you intended.
Band-based rebalancing sets a threshold — for example, rebalance whenever any asset class drifts more than five absolute percentage points from its target — and acts only when that threshold is breached. This means you might trade zero times in a quiet year or three times in a volatile one. Band-based approaches respond to actual market conditions rather than an arbitrary calendar, and they tend to produce fewer unnecessary trades in calm periods while catching dangerous drift early in turbulent ones.
A worked example illustrates the difference. Assume a 60/40 stocks-and-bonds target with a five-point absolute band. Equities surge to 68 per cent in June: the band method triggers a rebalance back to 60 per cent immediately. Equities then fall to 54 per cent by September: the band triggers again, buying stocks back to target. By December, equities sit at 62 per cent — within the band, no further action needed. A calendar rebalancer, waiting until December, would have sat with 68 per cent equities for six months and then with 54 per cent for three months — both well outside their intended allocation.
Absolute and relative bands behave differently. A five-point absolute band on a 60 per cent equity target triggers at 65 per cent. A five-point relative band — five per cent of 60 — triggers at 63 per cent. Relative bands react faster to shifts in small allocations, which is particularly useful for volatile satellite positions like a crypto sleeve, where an absolute band would allow the holding to double before acting.
Rebalancing across tax wrappers
The tax cost of selling varies enormously depending on where the asset is held. Rebalancing inside a UK ISA or SIPP, or inside a US 401(k) or IRA, incurs no capital gains tax at all — you can sell and buy freely. In a taxable brokerage account, every disposal that realises a gain is potentially subject to tax: in the UK, capital gains above the £3,000 annual allowance are taxed at 18 or 24 per cent depending on your income band; in the US, long-term gains are typically taxed at 0, 15, or 20 per cent.
The optimal order of operations is to rebalance inside tax-sheltered accounts first, use new contributions to rebalance in taxable accounts, and only sell in taxable accounts when the drift is large enough to justify the tax cost — or when you can harvest a loss at the same time to offset the gain. A small tax bill to correct a meaningful risk imbalance is a reasonable trade; a small tax bill to correct a one-percentage-point drift is not.
Handling a crypto-heavy portfolio
Cryptocurrency allocations present a particular rebalancing challenge. A 5 per cent crypto holding can easily double to 10 per cent within months given typical volatility, but every disposal is a taxable event in most jurisdictions, and selling during a sharp downturn crystallises a loss you might prefer to leave uncrystallised.
The practical approach is to use wide absolute bands — for example, acting only when the crypto sleeve exceeds double its target weight — and to rebalance primarily by adding new money to other asset classes rather than by selling crypto. If you must sell, do so in tranches over several weeks to reduce the impact of price movements and to spread any tax liability. Redirecting staking rewards or yield to underweight assets serves the same function as dividend redirection in equities: it quietly rebalances without triggering a disposal.
Above all, accept that a volatile satellite allocation will drift more than the core of your portfolio. That is the price of holding it, and fighting every percentage point of drift with taxable sales is a losing game.
Keeping it simple
Rebalancing does not need to be complicated or frequent. For most investors, a once-a-year calendar review paired with directing new contributions at underweight assets is sufficient. If your portfolio includes volatile satellite positions — crypto, thematic ETFs, individual growth stocks — consider adding a band-based trigger for those sleeves while keeping the core on an annual schedule.
The ultimate goal is not perfectly hitting your target allocation on every given day. It is preventing your portfolio from drifting so far from your intended risk level that a market downturn delivers a surprise you are not prepared for. Automate what you can, rebalance inside tax shelters first, and resist the urge to over-engineer it. A simple plan you follow consistently beats a sophisticated one you abandon.