Short answer: rebalancing means bringing your portfolio back to the stock-and-bond mix you chose, after market moves have pushed it off course. Pick a rule in advance: either check on a schedule, such as once a year, or act only when a holding drifts past a set band. Do it the cheap way first, by sending new contributions to whatever is under target, and sell only where it costs nothing in tax, inside a 401(k) or IRA. In a taxable account, selling winners can create a capital gains tax bill, so weigh that before you trade.
Written for US investors. The portfolio example is hypothetical; tax rules are federal and summarized from IRS guidance.
Why a portfolio drifts
Each part of a portfolio grows at its own rate, so the mix changes on its own. The SEC’s beginner guide gives the classic case: a 60% stock target can become 80% after a stock market rise. Left alone, a portfolio tends to drift toward whatever has done best lately, which usually means more risk than you signed up for. Rebalancing, in the SEC’s words, is “bringing your portfolio back to your original asset allocation mix.”
A worked example
Hypothetical portfolio and returns. A three-fund portfolio starts at $500,000 with a 60/20/20 target. Over a year, US stocks return 20%, international stocks 5% and bonds −2%.
| Fund | Target | Start | After the year | Weight now | Trade to get back to target |
|---|---|---|---|---|---|
| US stocks | 60% | $300,000 | $360,000 | 63.9% | Sell $22,200 |
| International stocks | 20% | $100,000 | $105,000 | 18.7% | Buy $7,600 |
| US bonds | 20% | $100,000 | $98,000 | 17.4% | Buy $14,600 |
| Total | 100% | $500,000 | $563,000 | 100% | $0 net |
Calendar or threshold?
The SEC guide describes both approaches: rebalancing on a regular interval, such as every six or twelve months, or only when an asset class moves more than a set percentage, adding that rebalancing tends to work best when done relatively infrequently.
| Approach | How it works | Trade-offs | In the example |
|---|---|---|---|
| Calendar | Check on a fixed date, such as once a year, and trade back to target. | Simple and easy to remember; may trade when drift is tiny, or wait while drift grows large between dates. | An annual check trades all three funds as in the table. |
| Threshold | Trade only when a fund leaves a band you set, such as ±5 percentage points of its target. | Trades only when it matters; needs checking more often, and the band width is a judgment call. | US stocks at 63.9% are inside a 55–65% band, and both 20% funds are inside 15–25%: no trade yet. |
| Both | Check on a schedule, trade only if outside the band. | Combines a routine with fewer trades. | No trade this year; check again next year. |
Rebalance with new money first
The SEC lists a third way besides selling and buying: changing your contributions so more goes to under-weighted categories. For someone still saving toward FIRE, that is often enough on its own. In the example, suppose $40,000 of new savings arrives. The new total is $603,000, so the targets become $361,800, $120,600 and $120,600:
| Fund | Value now | New target | Put new money here |
|---|---|---|---|
| US stocks | $360,000 | $361,800 | $1,800 |
| International stocks | $105,000 | $120,600 | $15,600 |
| US bonds | $98,000 | $120,600 | $22,600 |
| Total | $563,000 | $603,000 | $40,000 |
The portfolio is back on target without a single sale, so there is no tax and no trading cost beyond the purchases you were making anyway. Once you retire and stop contributing, the same idea works in reverse: take withdrawals from whatever is over target.
Taxes and trading costs
The SEC guide’s main caution is to check whether your method will trigger transaction fees or tax consequences. Where you trade decides most of that:
- 401(k)s and IRAs. According to the IRS, amounts in an IRA, including earnings and gains, generally aren’t taxed until they’re distributed, so selling one fund to buy another inside the account doesn’t create a tax bill. If your accounts are spread out, rebalance here first.
- Taxable accounts. Selling a fund for more than you paid realizes a capital gain. Assets held more than one year produce long-term gains, taxed at lower rates; one year or less, short-term gains, taxed as ordinary income (IRS Topic 409). Hypothetical: if the $22,200 of US stock sold in the example had cost $16,000, the $6,200 long-term gain taxed at 15% would cost $930. Topic 409 puts the 15% rate on 2025 taxable income above $48,350 for single filers; below that, the rate can be 0%.
- Trading costs. Online trades of US stocks and ETFs cost $0 at the large brokerages we compared, but other companies’ mutual funds can carry a transaction fee of $20 to $100 per purchase depending on the broker and fund, plus fees for selling within 60 days of buying; see the brokerage comparison. Small, frequent trades are where these add up.
Rebalancing doesn’t make your money grow faster; its job is to keep risk where you chose it. Costs work directly against returns, as our guide to investment fees and your FIRE date shows, so the best rule is one you can follow cheaply.
Rebalancing near and in retirement
Your target itself may change as you get close to retiring, for example by holding more bonds for the first years of withdrawals, when a market fall does the most damage (see sequence-of-returns risk). Rebalancing keeps you at whatever target you set; deciding the target is a separate choice.
A rebalancing checklist
- Write down your target mix, counting every account (401(k), IRA, taxable) as one portfolio.
- Choose your rule: a date, a band, or a date with a band.
- On the date, or when a band is breached, work out each fund’s weight and its gap to target.
- Close the gaps with new contributions or, in retirement, with withdrawals.
- If that isn’t enough, trade inside tax-advantaged accounts.
- Sell in a taxable account only after checking the gain, the holding period and any fees.
- Note the date and what you did, so next year’s check is quick.
Sources
- SEC, Beginners’ Guide to Asset Allocation, Diversification, and Rebalancing.
- IRS, Publication 590-A (2025): tax treatment of amounts in an IRA.
- IRS, Topic no. 409, Capital gains and losses.
- Trading fees: Fidelity, Vanguard and Schwab fee schedules, as cited in our brokerage comparison (checked October 29, 2026).
Related reading: the three-fund portfolio for choosing the target, investment fees and your FIRE date, and sequence-of-returns risk.
